By Mark E. Battersby / Published May 2015
The IRS has long provided guidance to the pressure washing industry for capitalizing and depreciating their business property. Largely lost in even the most recent regulatory guidance however, are the proper procedures—and deductions for disposing of any unused, unneeded, or unwanted business assets or property.
Every once in a while one or more items of business property may no longer be useful: that old machine that broke down for the very last time or a truck that’s ready for a trade in but you wouldn’t be able to get a dollar for it. When this happens, the pressure cleaning business may claim an abandonment loss on its income tax return.
However, in order for the IRS to accept a bona fide abandonment of any business asset, there must be an actual intent to abandon it. There must also be an “overt” act to abandon the asset. Not too surprisingly, this two-pronged test can prove difficult.
Last year, the IRS issued regulations, the last major component of their long running efforts to provide updated regulatory guidance on the capitalization, depreciation, and disposition of tangible property. One clarification outlines how to apply the demolition of structures rules when electing to terminate general asset account treatment of a structure. The other clarifies when “any reasonable method” may be used to determine the unadjusted depreciable basis of assets in a partial disposition.
Apparently, a reasonable method might result in a calculated basis that is somewhat different than an amount that might be computed using a pressure washing operation’s records. The magnitude of the difference might call into question the reasonableness of the method, but the IRS chose to avoid this question by simply restricting use of the reasonable method to situations in which the business’s records are insufficient.
Under the IRS’s guidelines, a pressure cleaning business cannot merely set aside a piece of equipment and call it abandoned—the IRS might see a potential for future use. Items other than vehicles and equipment can also qualify for an abandonment loss deduction. It is possible to claim an abandonment loss for intangible assets such as goodwill.
According to the tax laws, a pressure cleaning business abandons property when it voluntarily and permanently gives up possession and use of the property with the intention of ending ownership but without passing it on to anyone else. The item must be disposed of, destroyed, donated to charity, or converted to personal use.
While abandonment is generally not treated as a sale or exchange of the property, if money does change hands, such as with a trade-in, and if the amount realized (if any) is more than the property’s adjusted basis, there is a gain. If the adjusted basis or book value is more than the amount realized (if any), then a loss results. Naturally, a loss from the abandonment of business or investment property is deductible as a loss.
What’s more, a loss from the abandonment of business or investment property that is not treated as a sale or exchange is generally an ordinary loss. And ordinary losses are usually more beneficial than capital losses that have limited deductibility.
While a deduction can be taken for the abandonment of a partnership interest, no loss deduction results from the abandonment of a home or other property held for personal use only.
A pressure cleaning business that consists of several “components,” such as subsidiaries, profit centers, branches or departments, must report the disposition or the discontinued use of any component that meets two general conditions:
• The component’s operation and cash flows have been or will be eliminated as a result of the disposal.
• The pressure cleaning business will not have any significant continued involvement in the component’s operations after the disposal.
The defining characteristic of an intangible asset is the lack of physical existence. Nevertheless, assets such as goodwill, patents, copyrights, trademarks, brands, franchises, and similar items contribute to the earnings capability of some businesses.
Although intangible assets cannot be physically abandoned, the courts have concluded that they may be treated as abandoned when a taxpayer demonstrates its intention to abandon the property coupled with an “act” of abandonment. Generally, this means that intangibles either need to be disposed of or abandoned through a formal process such as a corporate resolution, withdrawal from participation in any activity involving the intangible or cancellation of legal rights. Mere worthlessness is not enough. Naturally, the pressure cleaning business must have evidence to support the fact that the intangible asset has been abandoned or sold.
If an intangible asset was acquired, the rules label it a Section 197 intangible asset and deny an abandonment deduction if other intangible assets acquired at the same time are retained. Thus, if multiple intangibles were valued and recorded when originally purchased, the contractor or pressure cleaning business cannot deduct an abandonment loss for only one of the assets in the group. Instead, the tax rules require the basis or book value of the remaining Section 197 intangibles be increased by the basis remaining in the abandoned asset.
Many pressure cleaning businesses continue to hold and use property that they should and eventually will dispose of. Fortunately, there are other options for getting rid of long-lived business property, equipment, and assets. In addition to abandonment, trade-ins, or what lawmakers call an exchange for a similar productive asset, or distribution to the operation’s owners, shareholders, or key employees in a spin-off are alternatives.
Any long-lived asset the contractor or business abandons is considered disposed of when the business stops using it. A temporarily idle asset is not accounted for as abandoned. If a business plans to abandon a long-lived asset before its estimated useful life, it will treat the asset as held and used, test it for impairment, and revise depreciation estimates.
In the eyes of the IRS, continued use of any long-lived asset demonstrates service potential (the unit is useable), and thus, fair value would be zero only in unusual
circumstances. During use before abandonment, the pressure cleaning business should depreciate the asset so that at the time of disposal or abandonment, its carrying value equals its salvage value.
A long-lived asset that is to be distributed to the operation’s owners or exchanged for a similar productive asset is considered disposed of when it is actually distributed or exchanged. What occurs when the pressure washing operation continues to hold and use equipment or business assets whose value is diminished or “impaired?”
Some business assets are considered to have an indefinite life and cannot be amortized or written-off. Instead, they are periodically evaluated for “impairment.”
When an asset is being held and used, any test for recoverability is based on using the asset for its remaining useful life and assuming that disposal will not occur. If the carrying amount or basis exceeds its market value at the time of disposal, the pressure cleaning business is required to recognize an impairment loss.
In other words, when the basis, book value, or carrying amount of any long-lived business asset (or group of assets) is not recoverable from expected future cash flows, an impairment has occurred. The pressure cleaning business no longer expects to be able to generate a return from the asset sufficient to recapture its net book value. A loss is then recognized for the amount needed to reduce the asset to its fair value.
Since the asset remains in service, albeit with a lower book value, that downwardly revised carrying value will be depreciated over any remaining estimated life or used to determine an eventual abandonment loss.
How does anyone know when impairment occurs? Or better yet, how can that impairment be measured? Obviously, subjective assessments are necessary. Consideration of factors such as: a significant decrease in market value, a physical condition has declined unexpectedly, the asset is no longer used as intended, legal or regulatory issues have impeded the asset, or the business seems threatened by an asset’s performance, all indicate impairment.
Over time, productive assets used in a pressure cleaning business may no longer be needed and the decision made to dispose of them. That disposal may occur by abandonment, sale, or exchange and involve items other than vehicles and equipment, all of which may be subject to abandonment and thus, a loss from abandonment.
Even abandonment of items other than equipment or property, tangible or intangible, is deductible as a loss. A loss from an abandonment of property, other than a sale or exchange, is usually an ordinary loss. For the IRS to judge a bona fide abandonment, the pressure cleaning business must show intent to abandon the asset, and must overtly act to abandon it.
Because of the complexity of the rules and necessity of proving an actual act of abandonment, professional assistance is strongly recommended—the abandonment loss is often worth the expense and the effort.