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Cost Segregation: More Important Than Ever?

Posted by Don Warrant on 11/15/18 4:26 PM

cost-segregation-more-important-than-everYou and your clients may be thinking that the proposed tax reforms will impact the utilization of cost segregation. Will the proposed changes to the tax law make cost segregation obsolete?

In recent years, the IRS and U.S. Treasury have created complexities when determining the proper tax treatment of expenditures related to commercial buildings. This is the result of the interaction of the federal cost recovery rules, the tangible property regulations, and the classification of improvements to commercial buildings as “qualified improvement property” and/or “qualified real property.” As a result of these changes, cost segregation has become more important than ever!

The capitalization or expensing of costs in the current year impacts the treatment of similar costs in future years under the tangible property regulations. Therefore, it is important to make the right decisions when capitalizing or expensing costs. Cost segregation is an important tool used to make these decisions.

If and when tax reform does occur, there will likely be many states that do not conform to the federal rules, or may transition over a period of years. As a result, cost segregation will continue to fulfill an important role in those states. 

In addition, as we have written before, there are many compelling reasons to perform cost segregation. Many of those reasons are discussed below.

2015 PATH Act

The Protecting Americans from Tax Hikes (PATH) Act of 2015 had a significant impact on the importance of using cost segregation specialists to compare the tax benefit of renovating an existing building vs. building construction. Since building construction doesn’t qualify for bonus depreciation, renovating existing buildings can generate significant tax savings, creating a source of funds to finance the project.

Other important uses of cost segregation include:

  • Bonus Depreciation and Section 179 Expense. A cost segregation study identifies “qualified property” for bonus depreciation and year-of-purchase expensing.
  • Accelerated Tax Deductions. A cost segregation study creates accelerated tax deductions by accelerating the period over which the cost of assets are recovered for tax purposes. Assets identified in a cost segregation study are reclassified from a 39-year cost recovery period to a 5-year, 7-year, or 15-year cost recovery period.
  • Tax Deferred Exchanges. The IRC Section 1031 exchange provision is a valuable strategy to defer the recognition of gain on the sale of buildings. Cost segregation used in connection with a tax deferred exchange can generate tax savings in addition to tax deferral.
  • Estate Tax Planning. A cost segregation study can be used to generate tax savings for both the decedent and the heirs of real estate by segregating costs for both parties before and after the date of death.
  • Partial Disposition of Building Property. Cost segregation is generally necessary to determine the adjusted tax basis of the portion of building property that was partially disposed of in connection with the partial disposition election.
  • Improvement vs. Repair Analysis. Cost segregation is generally necessary to determine whether expenditures improve or repair the building structure or any building system, and to determine the appropriate unit of property.
  • Tenant Improvement Costs Analysis. Cost segregation is often necessary to segregate the cost of tenant improvements between building property and tangible personal property, and to determine which expenditures are capital improvements or repairs.

Other uses of cost segregation include tax planning in the year of a building’s sale, to qualify for the small taxpayer safe harbor election, and for federal and state income tax planning. 

In summary, cost segregation is more important than ever, especially for buildings placed in service in years preceding any federal or state tax reform that reduces tax rates.

CSP360 is ready to assist you and your clients with these important uses of cost segregation, and to generate tax savings for your clients.

Tags: cost segregation, cost segregation study, tangible property regulations, tangible property

Cost Segregation Services: It’s Not Too Late for Your Clients to Qualify for 2016 Tax Deductions

Posted by Don Warrant on 4/13/17 9:00 AM

IRS cost segregation guidance in 2016 and 2017 makes it possible to qualify for 2016 deductions even after January 1, 2017.

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Both the president and the Majority-Republican House of Representatives have proposed significant changes to the Internal Revenue Code (IRC). While they don’t agree on every point, they share a common cornerstone in that both would significantly reduce income tax rates for businesses and individuals. There is no guarantee that a tax rate reduction will occur in 2017, but the Trump administration is on record with a statement that a tax package will be part of its agenda in the first 100 days. That means legislation could be in play before the end of April this year.

In any year, you will generally recommend accelerating deductions (unless certain circumstances exist) based on savings resulting from the time value of the money deducted. That recommendation becomes stronger in a year like 2016, when there’s reason to expect that rates may drop in 2017.

The deductions are worth more in the year of higher rates. Effectively, you have a small window of opportunity to deliver tax benefits that might not be available next year.

Cost Segregation Studies and 2016 Tax Deductions

For the most part, your ability to generate tax deductions for clients for 2016 are generally limited once the calendar year ends. However, recent IRS rule changes make it possible to claim 2016 deductions based on cost segregation studies performed in 2017.

In some cases, a study may even result in tax-reducing amendments to returns already filed for the 2016 tax year. We often hear that clients put off cost segregation studies because the accelerated deductions are “only a temporary timing difference.” At this point, the significant possibility of reduced tax rates in the near future adds incentive in the form of a permanent timing difference to claim available tax deductions in a year with higher tax rates such as 2016.

The result of a cost segregation study performed on building property placed in service in prior years is reported as additional tax depreciation for the 2016 tax year using the automatic change in accounting method procedures outlined in Rev. Proc. 2015-13 and Rev. Proc. 2016-29. Under these procedures, your client automatically has until the extended due date to claim the additional tax depreciation on an original or amended tax return.

Five-Year Eligibility Rule Waiver

In addition, Notice 2017-6 waives the five-year “eligibility rule” that otherwise would prohibit your clients from using the automatic method change procedures to make the same change in method of accounting for a specific item more than once within a five-year period. 

The waiver of the five-year eligibility rule found in Section 5.05 of Rev. Proc. 2015-13 applies to the following automatic changes in accounting method allowed by Rev. Proc. 2016-29: 

  • Section 6.14 for a change in method of depreciation from a permissible method to another permissible method;
  • Section 6.15 for a change in method of accounting for dispositions of a building or structural components;
  • Section 6.16 for a change in method of accounting for dispositions of tangible depreciable property (other than a building or structural components);
  • Section 6.17 for a change in method of accounting for dispositions of depreciable property in a general asset account; and
  • Section 11.08 for a change in method of accounting for tangible property under the final tangible property regulations.

How to Help Give Your Clients the Good News About Cost Segregation Tax Deductions

Actions like these show that the IRS is doing what it can through its guidance channels to facilitate the transition to the tangible property regs. In doing so, the Service is also opening opportunities for you to help your clients claim deductions in 2016 or earlier based on the results of cost segregation studies and related information.

If your practice is currently in the midst of the typical filing season rush but you have clients that could benefit, this could be an excellent time to outsource a cost segregation study to a provider focused on this specialized practice. CSP360’s CPA Partnership Program could be just what you need to deliver this valuable additional service to your clients at a time when your staff is at full capacity.

For more information on the cost segregation services that CSP offers, call Don Warrant, CPA at 716-847-2651.

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Tags: Don Warrant, deductions, cost segregation, cost segregation study

Court Cases Show the Importance of Tax Knowledge in Cost Segregation Studies

Posted by Jennifer Birkemeier on 3/29/17 9:03 AM

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You probably know that preparing your clients’ cost segregation studies requires specialized knowledge of their industry. You might not realize, however, the importance of tax knowledge—especially when it comes to conforming the studies to new IRS Audit Technique Guides (ATGs).

Know the Rules Before Making Any Decisions

The Court of Appeals for the 11th Circuit has concluded that for depreciation purposes, a taxpayer couldn’t unilaterally change its original purchase price allocations in two asset purchase agreements entered into in connection with acquiring certain assets.

In Peco Foods, Inc. & Subsidiaries v. Comm., the taxpayer had attempted to make the modifications in order to secure quicker depreciation deductions following a cost segregation analysis. The 11th Circuit agreed with the Tax Court that the law had been applied correctly.

Case background showed that Peco Foods acquired one poultry plant from Green Acre Farm, Inc. in 1995 for $27,150,000 and, in 1998, one poultry plant from Marshall Dublin Food Corp. and Marshal Dublin Farms for $10,500,000. As part of the purchase agreements, both parties agreed to and included a purchase price allocation (PPA) in the purchase documentation.

At issue in the Tax Court case was the classification of a “Processing Plant Building” on one purchase and the “Real Property: Improvements” on the other purchase. Peco initially depreciated these assets as nonresidential real property (39-year) before performing a cost segregation study on each.

The Tax Court ruled the study invalid because of the PPA. The PPA went as far as delineating the costs for items such as specific process-related items, land improvements, buildings and goodwill. Further, the PPA was explicit about the definitions of real and personal property as they pertained to the specific transaction. In addition, the PPA contained specific language that the allocations were to be used for all purposes including financial accounting and tax purposes. The taxpayer also filed the detail listing with their tax return as part of the Form 8594 for their respective year of purchase.

The decision in Peco points out that one must pay attention and know the rules before making decisions on what you put into a purchase agreement, as this can determine your options including whether one can perform a cost segregation study.

The second case, AmeriSouth v. Commissioner, hinged on the allocation of rental real estate assets into appropriate classes for calculating depreciation expense and how a quality study pinpoints all shorter-life personal property, such as furniture, fixtures and equipment, and land improvements, from the longer life 27.5-year residential building life and non-depreciable land. Recently taxpayers have also qualified for 50% and 100% bonus depreciation on any newly placed-in-service personal property and land improvements.

In AmeriSouth, the judge decided that many of the assets of the petitioner’s 40-building, 366-unit apartment complex should be reclassified from personal property to building. AmeriSouth purchased a $10.25 million market-rate apartment complex in 2003 and spent $2 million in renovations. They hired consultants to perform a cost segregation study that resulted in increased depreciation deductions of approximately $1,412,000 from 2003-2005. The IRS commissioner subsequently denied deductions of more than $1 million. AmeriSouth then filed its petition to challenge.

One major point of this case: The court places the burden of proof on the taxpayer to provide support for why an asset should have a shorter depreciable life. AmeriSouth fell short in this area. If they had followed the ATG, the company wouldn’t have taken the position it did.

As we see in AmeriSouth, the taxpayer did not substantiate their position under IRS audit since they had sold the building before trial began. It is unknown how the case would have been decided if the taxpayer had been responsive in this case. AmeriSouth took many positions that most cost segregation providers do not take. An accurate analysis of the statutes and judicial precedent for the positions taken in AmeriSouth could have avoided a costly legal challenge in court.

A Quality Cost Segregation Services Provider Has Quality Tax Experience

Cost segregation services are not just a commodity where your client should pick the lowest bidder. Make sure your clients know that the best way to prepare a cost segregation study based on the latest ATGs is to choose a provider with thorough tax knowledge. If you partner with another firm for this service to clients, understand the credentials of your partner firm and their expertise in cost segregation. Contact us for help.

Tags: accounting methods, cost segregation, cost segregation study, Jennifer Birkemeier

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