Loss on sale of production equipment is treated as non-DPGR
IRS guidance addresses treatment of equipment sale for DPAD
TAX ALERT |
The IRS recently released a Chief Counsel Advice (CCA) memorandum addressing certain consequences of an equipment sale on a taxpayer’s domestic production activities deduction (DPAD). CCA 201642033 responds to the question of whether a loss on a sale of equipment purchased to produce qualifying production property (QPP) should reduce qualified production activities income (QPAI).
Under the facts described in the CCA, a taxpayer purchased a piece of equipment and used it solely to produce QPP, the sales of which generated domestic production gross receipts (DPGR). After three years, the taxpayer sold the equipment at a loss. The CCA stated that the sale did not generate DPGR as the equipment was not QPP manufactured, produced, grown or extracted (MPGE) by the taxpayer.
Under section 199, a taxpayer who meets the DPAD requirements is allowed a deduction equal to 9 percent of the lesser of the taxpayer’s QPAI or taxable income. A taxpayer’s QPAI is determined by subtracting the cost of goods sold (CGS) and other expenses, losses or deductions that are allocable to the DPGR from the DPGR. The taxpayer’s DPGR is made up, in part, of the gross receipts the taxpayer derives from the lease, rental, license, sale, exchange or other disposition of QPP that is MPGE in whole or in significant part within the United States.
For the purposes of determining the gross receipts that should be characterized as DPGR or non-DPGR, the regulations provide that gross receipts are not reduced by CGS nor by the cost of property if that property was inventory or depreciable business property. These amounts must, therefore, be characterized as either DPGR or non-DPGR.
In determining the amount of CGS allocable to DPGR and non-DPGR, a taxpayer can use any reasonable method based on the facts and circumstances. However, if the taxpayer has information readily available to specifically identify the CGS amounts allocable to DPGR and non-DPGR, then the taxpayer must use those amounts. In the case of a sale or disposition of non-inventory property, the regulations provide that CGS includes the amount of the adjusted basis of the property sold.
In the facts of the CCA, the taxpayer’s equipment was depreciated and capitalized to the QPP. The taxpayer allocated its CGS properly between DPGR and non-DPGR. However, because the equipment was not QPP in the hands of the taxpayer, the gross receipts from the sale should be categorized as non-DPGR. The IRS stated that the taxpayer, likely having the information available to specifically identify the equipment’s adjusted basis, should include this amount as CGS allocable to non-DPGR received on the sale of the equipment. Therefore, the adjusted basis of the equipment will not reduce the taxpayer’s DPGR nor its QPAI.
Although CCAs are based on a specific set of facts and are not permitted to be used as precedent, this memorandum provides insight as to how the IRS might rule on a similar set of facts. Taxpayers who produce QPP through a piece of equipment later sold should consult with their tax advisors to determine how the results in this CCA may be applicable