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Multiple AMT asset bases; significant planning opportunities may result from a variety of basis computations.

Most corporate assets have a unique basis for each distinct tax computation (i.e., for regular income tax, alternative minimum tax (AMT), adjusted current earnings (ACE), and earnings and profits (E&P)). Taxpayers would do well to plan their asset dispositions and take advantage of the many tax planning opportunities that exist as a result of the separate basis computations. These computations can produce significant tax savings or alter the time at which tax refunds and credits are available. However, due to the complexity of the post-1986 corporate AMT, significant tax savings may easily be overlooked. This article will illustrate, with examples, how to achieve those tax savings.

ACE Adjusted Bases

Sec. 56(g)(4)(I), added by the Technical and Miscellaneous Revenue Act of 1988 (TAMRA), lacks precision, but appears to require that the adjusted basis of any property for ACE purposes is determined by considering the depreciation computed for ACE purposes. This is a logical approach and a reasonable interpretation.

There is no commentary in the TAMRA committee reports regarding Sec. 56(g)(4)(I), and the final ACE regulations, issued in March 1991, do not address this provision. However, the wording of Sec. 56(g)(4)(I) is reasonably similar to Sec. 56(a)(7), which provides for a distinct AMT basis for most modified accelerated cost recovery system (MACRS) property. This AMT basis (hereinafter referred to as the preadjustment alternative minimum taxable income (AMTI) basis) equals the property's initial depreciable basis plus any capitalized improvements less the depreciation allowed by Sec. 56(a)(1) for preadjustment AMTI purposes.(1) Thus, most MACRS property has one basis for regular income tax purposes, but another basis for preadjustment AMTI purposes. The Senate Report to the Tax Reform Act of 1986 (TRA) explained Sec. 56(a)(7) as follows. For all depreciable property to which minimum tax adjustments apply, adjusted basis is determined for minimum tax purposes with reference to the amount of depreciation allowed for minimum tax purposes under the alternative system [i.e., the alternative depreciation system (ADS)]. Thus, the amount of gain on the disposition of such property will differ for regular and minimum tax purposes.(2) (Emphasis added.)

Given the similar wording of Secs. 56(a)(7) and 56(g)(4)(I), it appears that a distinct ACE basis was intended for most ACRS and MACRS property. Assuming this is true, the ACE basis for these properties equals the property's initial depreciable basis plus any capitalized improvements less the depreciation allowed for ACE purposes.(3) Thus, in computing ACE, a corporate taxpayer selling depreciable property often has one gain or loss adjustment for preadjustment AMTI purposes and a second gain or loss adjustment for ACE purposes. The difference in the respective bases (see Example 1 on page 47) presents a significant opportunity to reduce or eliminate a post-1989 corporate tax liability (regular tax, AMT or both).

Example 1: Determining Adjusted Bases

L Corp., a calendar-year C corporation, placed $5000,000 of class 33.3 assets (Manufacture of Foundry Products) into service in June 1987. For MACRS purposes, these assets are seven-year property with an ADS recovery period of 14 years. The regular income tax and AMT bases of these properties on Jan. 1, 1990 are determined as follows.
 Regular AMT
 tax basis basis
 Initial basis $500,000 $500,000
 Less depreciation for each
 purpose (1987-1989) 281,350 122,750
 Adjusted basis at 1/1/90 $218,650 $377,250


Under Sec. 56(g)(4)(A)(ii), ACE depreciation for this property is determined as follows.

$377,250 (adjusted basis

for AMT purposes at 1/1/90) = $32,804 (annual
 11 1/2 years (remaining ACE depreciation)
 ADS recovery period


applicable to the property) As a result of the three depreciation computations, this property has three distinct bases at the end of each post-1989 tax year (December 31 in this case).
 Adjusted basis
 for regular Adjusted basis Adjusted basis
Year-end tax purposes for AMT purposes for ACE purposes
 1990 $156,200 $336,850 $344,446
 1991 111,550 300,750 311,642
 1992 66,950 268,550 278,838
 1993 22,300 236,950 246,034
 1994 0 205,350 213,230


The preadjustment AMTI adjustments required by Sec. 56(a) (including the AMTI basis adjustment of Sec. 56(a)(7)) are allowed without reference to prior-year adjustments and may reduce preadjustment AMTI below taxable income for regular income tax purposes. However, negative ACE adjustments are limited to prior-year positive adjustments by Sec. 56(g)(2).

The possibility of combining large negative adjustments for preadjustment AMTI with those for ACE purposes suggests that taxpayers may obtain significant tax benefits through selected asset dispositions.

ACRS Property

The ACE depreciation adjustment for most ACRS property (generally property placed in service after 1980 and before 1987) is based on the following formula.

Adjusted basis of the property

for regular tax purposes

at the close of the last tax year

beginning before 1990

Remaining recovery period

applicable to the property

under the ADS of Sec. 168(g)

= Annual ACE depreciation for ACRS property Note: In computing the numerator of this formula, the adjusted basis is that determined for regular income tax purposes. This differs significantly from the numerator used for the MACRS property in Example 1.

In computing the denominator for ACRS property, the final ACE regulations provide that the taxpayer must apply the ADS lives to properties placed in service at a time that predates the adoption of the ADS (which was introduced with the MACRS in 1986).(4) The specification in Regs. Sec. 1.56(g)-1(b)(3)(ii) of the lives "under section 168(g)(2)" without a reference point (date) may cause confusion as several amendments to the original Sec. 168(g)(2) recovery periods were made by the TAMRA.(5)

Sec. 56(a)(7), which mandates a distinct preadjustment AMTI basis for assets, applies only to MACRS property. No unique preadjustment AMTI basis is provided for ACRS property. However, Sec. 56(g)(4)(I) draws no distinction between MACRS and ACRS property. Thus, both MACRS and ACRS property have a unique ACE basis for gain or loss purposes, while only MACRS property has a preadjustment AMTI basis that differs from its regular tax basis. See Example 2 on page 48.

Example 2: Recovering ACE Basis

T Corp., a calendar-year C corporation, placed $800,000 of class 37.11

assets (assets used in the Manufacture of Motor Vehicles) into service in

June 1986. These assets are five-year ACRS property, but for ADS

purposes (applied retroactively to ACRS assets for ACE purposes) they have

a 12-year life. The regular income tax and AMT bases of these assets on

Jan. 1, 1990 are determined as follows.
 Initial basis $800,000
 Less depreciation (1986-1989) 632,000
 Adjusted regular tax basis at 1/1/90 $168,000


This is the basis used for ACE depreciation purposes. The 1990 ACE

depreciation for this asset is determined as follows.

$168,000 (basis for regular tax)

8 1/2 years (12-year ADS life - 3 1/2 years elapsed at 1/1/90

For 1990, T has a regular tax depreciation deduction of $168,000 and an

ACE depreciation deduction of only $19,765. This results in a $148,235

positive adjustment in computing T's 1990 ACE. $148,235 is also the

ACE basis for this property on Jan. 1, 1991, while $0 is the regular tax

basis. T will recover the ACE basis over the next 7 1/2 years through annual

negative ACE adjustments of $19,765.

As Example 2 demonstrates, many taxpayers with ACRS assets placed in service in 1986 had significant positive 1990 ACE depreciation adjustments. However, the difference between the 1991 regular tax depreciation of the asset ($0 in the example) and the 1991 ACE depreciation of the asset ($19,765 in the example) produces a relatively small and negative ACE adjustment in 1991 and later years. See Example 3 on page 48.

Example 3: ACE Adjustment

Assume T Corp. from Example 2 has determined the following, relative

to its 1991 tax computations.
 Regular taxable income $210,000
 Preadjustment AMTI 300,000
 ACE (positive adjustments on MACRS
 property - $19,765 of ACE depreciation
 from the 5-year ACRS property in Example 2(*)) 340,000
 AMT credit available (due to large ACE
 adjustments in 1990)(**) 21,000


Under these conditions, T's 1991 AMT tax liability ($66,000) is computed

as follows.
 Preadjustment AMTI $300,000
 Plus ACE adjustment
 (0.75 x ($340,000 - $300,000)) 30,000
 AMTI 330,000
 Multiplied by corporate AMT tax rate x 0.2
 Tentative AMT $ 66,000


Because T's regular tax liability is $65,150 on $210,000 of regular taxable

income, an AMT of $850 would be payable for 1991. Thus, the available

AMT credit would become $21,850 for 1992.

* The property is fully depreciated for regular tax purposes after five years, but

(as noted in Example 2) it requires a negative ACE adjustment for an additional

7 1/2 years due to a 12-year ADS life.

** The AMT credit computation has been simplified for purposes of these

examples.

Example 3 reflects a significantly reduced ACE adjustment for the taxpayer's 1991 tax year. This is due to the fact that a large positive ACE adjustment for the ACRS property occurred in 1990; in later years the ACE depreciation on the five-year ACRS property reduces the taxpayer's ACE adjustment. Note that T has recovered none of the 1990 AMT resulting from the large ACE depreciation adjustment for the ACRS property; the annual $19,765 ACE depreciation is relatively inconsequential. However, T has a fully depreciated ACRS asset (for regular income tax purposes) that can produce significant 1991 tax savings. See Example 4 above.

Example 4: Depreciated ACRS Asset

If T Corp. from Examples 2 and 3 sold the ACRS asset for $50,000 in

1991, it could pocket the entire $50,000 sales price and produce additional

1991 tax savings, as follows.
 Regular taxable income after sale
 ($210,000 + $50,000 regular tax gain) $260,000
 Preadjustment AMTI after sale
 ($300,000 (from Example 3) + $50,000
 due to inclusion of regular
 income tax gain) 350,000
 ACE after sale
 ($340,000 (from Example 3) + $50,000
 increase in preadjustment AMTI due to
 sale + $19,765 ACE depreciation not
 claimed due to sale - $148,235 adjusted
 basis for ACE purposes at 1/1/91)(*) 261,530
 Regular income tax after sale
 (tax on $260,000) 84,650
 AMT tax after sale:
 Preadjustment AMTI $350,000
 Less ACE adjustment
 (0.75 x ($261,530 - $350,000))(**) 66,353
 AMTI before exemption 283,647
 Less corporate exemption
 (see Sec. 56(d)(2) and (d)(3)) 6,588
 AMTI 277,059
 Multiplied by corporate AMT tax rate x 0.2
 AMT 55,411
 Regular tax after sale (above) 84,650
 Less AMT credit (not to exceed
 $84,650 - $55,412 computed above) 21,000
 Tax payable with sale of Example 2 asset 63,650
 Tax payable without sale (from Example 3) 66,000
 Tax savings from sale producing $50,000
 of regular income tax gain $ 2,350


* For ACRS property other than realty, no depreciation is allowed in the year of

sale.

** The Sec. 56(g)(2) limitation on negative adjustments does not apply due to the

$148,235 positive ACE adjustment made in 1990 (see Example 2).

The tax savings computed in Example 4 result from the acceleration of the AMT credit. This acceleration is beneficial for at least two reasons. 1. Assuming no major change in marginal tax rates, the time value of money favors acceleration ($21,000 of utilized AMT tax credit is better than a potential tax credit at some future date). 2. The relatively small amount of annual ACE depreciation on this asset ($19,765) may not reduce the taxpayer's annual ACE to the extent that the taxpayer could ever benefit from an AMT credit (see Example 3).

While the ACE adjustment for ACRS real property is significant, it is not as large as it might seem. The difference between a 19-year, 175% declining balance (DB) depreciation deduction for regular tax purposes and a 40-year, straight-line (SL) depreciation deduction for ACE purposes is mitigated by the fact that the ACE depreciation formula for ACRS property uses the adjusted basis for regular income tax purposes in the numerator and spreads the deduction over 40 years reduced by the number of years in which the asset was in service before the taxpayer's first tax year beginning after 1989 (i.e., the denominator). Example 5: B, Inc., a calendar-year C corporation, placed a $1,000,000 commercial office building into service on June 30, 1986. The property is 19-year real property for ACRS depreciation purposes. Regular tax depreciation for 1990 is $65,000 (19-year, 175% DB) and 19-year SL depreciation results in $53,000 of depreciation. Assuming 19-year, 175% DB depreciation, the adjusted basis of the building on Jan. 1, 1990 is $711,000 ($1,000,000 (accumulated depreciation)) and 437 1/2 months of ACE depreciation remain. Thus, its annual ACE depreciation deduction is $19,502, computed as follows.

$711,000 / 437 1/2 months x 12 months = $19,502

Two significant questions arise when computing B's ACE adjustment. For preadjustment AMTI, the difference between the 1990 regular tax ACRS depreciation for the building ($65,000) and SL depreciation over a 19-year life ($53,000) represents a $12,000 tax preference item. Is the ACE adjustment the difference between regular tax depreciation ($65,000) and the ACE depreciation ($19,502) or, since $12,000 of this amount has already been reflected in preadjustment AMTI, is the ACE depreciation adjustment the difference between the two computations ($65,000 -- $19,502) reduced by the $12,000 tax preference relative to the building? Prop. Regs. Sec. 1.56(g)-1 did not address this issue. However, the final version of Regs. Sec. 1.56(g)-1(a)(6)(ii) added the following statement. To the extent an amount is included (or deducted) in computing pre-adjustment alternative minimum taxable income for the taxable year (whether because an adjustment is made under section 56 or 58, because of a tax preference item under section 57, or because the item is reflected in taxable income), that amount is not again included (or deducted) in computing adjusted current earnings for the taxable year.

Assuming the ACE adjustment is reduced by $12,000 to reflect the depreciation preference amount under this regulation, a question remains as to the proper ACE adjusted basis of the property. Recall that, for ACRS property, the adjusted basis of the property is the same for regular income tax and preadjustment AMTI purposes. The Sec. 56(g)(4)(I) basis adjustment for ACE purposes only refers to "an adjustment under this paragraph." Is the ACE basis adjustment for ACRS property the $45,498 ($65,000 -- $19,502) difference between regular tax and ACE depreciation, or is it the $33,498 ($45,498 -- $12,000 (preference amount)) adjustment made for ACE purposes?

Logic dictates that the amount used to adjust regular taxable income in the computation of preadjustment AMTI (i.e., the $12,000 tax preference amount) should not be considered a second time in the computation of ACE. However, since an ACRS asset does not have a distinct AMT basis (i.e., its regular tax basis equals its AMT basis), both the tax preference item and the ACE depreciation adjustment should be considered in the computation of the ACE basis. Unless they are considered, a taxpayer would be left with an ACE adjusted basis equivalent to its cumulative post-1989 tax preference amounts at the end of an asset's ADS life. See Example 6 on page 50.

Example 6: ACE Adjusted Basis

Assuming the ACE adjusted basis has been reduced to reflect the annual tax preference amount described in Regs. Sec. 1.56(g)-1(a)(6)(ii), e.g., $12,000 for 1990, B (from Example 5) has an opportunity to significantly reduce its ACE on a sale of the property. The following represents the significantly larger ACE adjusted basis for the property only through 1996.
 Adjusted Cumulative
 basis for ACE adjusted difference in
 Year-end regular tax basis adjusted basis
 1990 $646,000 $691,498 $45,498
 1991 587,000 671,996 84,996
 1992 533,000 652,494 119,494
 1993 484,000 632,992 148,992
 1994 439,000 613,490 174,490
 1995 397,000 593,988 196,988
 1996 355,000 574,486 219,486


Thus, a sale of the property on Jan. 1, 1994 for a $100,000 regular income tax gain would require a negative ACE adjustment of $148,992, reducing B's post-sale ACE by $48,992.

MACRS Property

The ACE adjustment for MACRS property is divided into two categories. 1. Sec. 56(g)(4)(A)(i) applies to MACRS property placed in service in a tax year beginning after 1989. For this property, ACE depreciation is the amount allowed under the ADS of Sec. 168(g), i.e., SL over the asset's class life. 2. Sec. 56(g)(4)(A)(ii) applies to MACRS property placed in service in a tax year beginning before 1990. For these properties, ACE depreciation is computed using the following formula.

Adjusted basis of the property for

AMT purposes at the close of the

last tax year beginning before 1990

/Remaining recovery period applicable

to the property under

the ADS of Sec. 168(g)

= ACE depreciation Assets in the second category have the potential to significantly reduce a corporate taxpayer's ACE adjustment for tax years beginning as early as 1990. See Example 7 on page 51.

Example 7: ACE Adjustment for MACRS Property

D Inc., a calendar-year C corporation, placed a $500,000 class 33.3 asset into service on June 30, 1987. This property is subject to the half-year convention and is depreciated over seven years for regular tax purposes, but 14 years for ADS purposes. The basis of this asset on Jan. 1, 1990 is as follows.
 Regular tax AMT adjusted
 adjusted basis tax basis
 Cost $500,000 $500,000
 Depreciation (1987-1989) 281,350 122,750
 Adjusted basis at 1/1/90 $218,650 $377,250


For 1990, the depreciation on this asset is $62,450 (the 200% DB percentage is 12.49%) for regular tax purposes, $40,400 (the 150% DB percentage is 8.08%) for preadjustment AMTI purposes and $32,804 ($377,250 (AMT basis) / 11 1/2 years (remaining ADS life at 1/1/90)) for ACE purposes.

The following table details the adjusted bases of this asset for years ending in 1990 through 1994.
 Adjusted
 Adjusted basis for Adjusted
 basis for preadjustment basis
 Year-end regular tax AMTI for ACE
 1990 $156,200 $336,850 $344,446
 1991 111,550 300,750 311,642
 1992 66,950 268,550 278,838
 1993 22,300 236,950 246,034
 1994 0 205,350 213,230


Thus, a 1990 sale of this asset will provide B with a $180,650 ($156,200 -- $336,850) negative adjustment in determining preadjustment AMTI and a further $7,596 ($336,850 -- $344,446) negative adjustment in determining ACE.

If the same asset were to be placed in service in 1990, the 1990 negative adjustment resulting from a sale is considerably smaller (but generally assets are not sold in the year they are placed in service). However, a significant difference in adjusted bases does arise over the years as follows.
 Adjusted
 Adjusted basis for Adjusted
 basis for preadjustment basis
 Year-end regular tax AMTI for ACE
 1990 $428,550 $473,200 $482,150
 1991 306,100 422,500 446,450
 1992 218,650 377,250 410,750
 1993 156,200 336,850 375,050
 1994 111,550 300,750 339,350


For MACRS realty, a difference in adjusted basis will arise for regular income tax purposes and preadjustment AMTI purposes (31 1/2-year SL for regular income tax versus 40-year SL for preadjustment AMTI), but no further difference in adjusted basis is created for ACE purposes (40-year SL is used for both preadjustment AMTI and ACE). Thus, a sale of MACRS realty will generally provide a negative preadjustment AMTI adjustment, but will not otherwise affect the ACE computation.

Conclusion

Significant tax savings opportunities can result from the judicious disposition of selected assets. These savings can result because of a variety of basis computations for regular tax and AMT purposes. If the taxpayer is skeptical about disposing of an asset that may have future utility in the taxpayer's business, a sale and leaseback arrangement may be feasible. The sale-leaseback transaction should be a viable option as long as the purchaser-lessor is unrelated to the seller-lessee and the lessor assumes some or all of the incidents of ownership (e.g., insurance and personal property taxes) that had previously been borne by the lessee. In other words, the form of the transaction should be respected as long as there is a valid business purpose for the sale-leaseback transaction. Certainly, the need to raise funds accompanied by a shifting of certain economic and financial risks from the seller-lessee to the purchaser-lessor is a valid business purpose. Taxpayers must consider the costs involved in these transactions (e.g., commissions, legal fees, etc.) as they may exceed any tax savings.

Corporate taxpayers would be well-advised to prepare pro forma AMT computations and to review their regular tax, preadjustment AMTI and ACE basis computations before the close of every tax year. Regular or AMT tax liabilities might be reduced by a judicious asset disposition before year-end. (1)Preadjustment AMTI is defined in final Regs. Sec. 1.56(g)-1 (a)(6)(i) as "the alternative minimum taxable income of the taxpayer for the taxable year, determined under section 55(b)(2), but without the adjustment for adjusted current earnings and without the alternative tax net operating loss deduction under section 56(a)(4)." (2)S. Rep. No. 99-313, 99th Cong., 2d Sess. 524 (1986). (3)Sec. 56(g)(4)(A). (4)Regs. Sec. 1.56(g)-1(b)(3)(ii)(C). (5)TAMRA Sections 1002(i)(2)(F), 6027(b)(2) and 6029(c).
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Author:Gaffney, Dennis J.
Publication:The Tax Adviser
Date:Jan 1, 1992
Words:3689
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