economics of cost segregation
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Cost Segregation delivers results every time it's applied!TRANSCRIPT
Economics of Cost Segregation
Cost Segregation Delivers Results Every Time It’s Applied!
Presented by:Jeff Hobbs
andBrian Mitrzyk
(pronounced “Me-Check”)
What is Cost Segregation?
It is the process of identifying property components that are considered "personal property" or "land improvements" under the federal tax code. It identifies and reclassifies personal property assets to shorten the depreciation time for taxation purposes, which reduces current income tax obligations.The US Treasury Department States:“Cost segregation is a lucrative tax strategy that should be used in almost every major purchase of commercial real estate.”
Wall Street Journal – June 2003
Cost Segregation & the IRS• 1997 - HCA sued the IRS and won $800,000,000+
• IRS Chief Counsel : Requires Cost Segregation Study be based on contemporaneous records & be fact-based*
• IRS Revenue Procedure 98-60• IRS Rev. Proc. 99-49/IRC 481/4 Years• IRS Announcement 2002-37• IRS Rev. Proc. 2002-9• IRS Rev. Proc. 2002-18• IRS Rev. Proc. 2002-19/IRC 481(a)• Actual Case : Chief Counsel Advice 1999-21945,
5/28/99, IRS Announcement 99-82• *http://www.irs.gov/Businesses/Cost-Segregation-
Audit-Techniques-Guide---Chapter-2---Legal-Framework#18
Recent History
• 2002 –IRS consents to changes in the method of depreciation via Form 3115, filed in the year the change is elected. Taxpayers permitted to catch up on all deductions from previous years. No amended returns required.– This “catch-up” is via IRS §481(a) and the adjustment is granted
“automatic consent” by IRS Chief Counsel.
• 2004 – IRS releases Cost Segregation Audit Technique Guide (CSATG).
• 2006 – The IRS starts to crack down on non-engineering based study-providers and audits them more frequently.
• 2011 – Economic Stimulus Plan – 100% Bonus Depreciation
• 2014 – Bonus Depreciation expired, §179 reverts to $25,000
IRS CSATG Quote
• The wide gap in MACRS recovery periods provides a strong incentive for taxpayers to allocate or reallocate costs of long-lived property to short-lived property, wherever possible.– http://www.irs.gov/Businesses/Cost-
Segregation-Audit-Techniques-Guide---Chapter-2---Legal-Framework#6
Questions From the “Field”
• Who can perform a cost segregation study?
• What qualifications does he/she need?• What documentation is needed?• When can the study be performed and
when is the best time?• What reports are made to the IRS, and
how?• What is the IRS code section involved?• What is the minimum asset basis for a
cost segregation study to make sense?
Questions From the “Field” 2
• How do the new “Repair & Maintenance” rules impact cost segregation studies, if at all?
• How do the new “Repair & Capitalization” rules impact cost segregation studies, if at all?
• I want a "cookbook approach" of how to do this for real estate -- when you can and cannot under new legislation -- for leasehold improvements, repairs and new construction. etc.
Questions From the “Field” 3• Are there new opportunities available
for a cost segregation study under the new regulations?
• What are the steps involved in the process?
• What qualifications should be considered in hiring a cost segregation firm?
• Does cost segregation have other benefits?
• What about the Inherent Permanency Test & the Whiteco Factors?
Questions From the “Field” 4• How can a CPA best work with a cost
segregation firm to save time and money for the client?
• How are cost segregation analyses billed; on a fixed contract or percentage of dollars invested in the real estate that is the subject of the analysis?
• A case study from a recent cost segregation engagement with the amount of tax savings to the client would be helpful.
Who Can Perform a CSS?
The IRS Chief Counsel wrote a memo saying, ". . . Cost Segregation, for it to be properly applied, had to involve those with competencies in architecture, engineering or construction and/or construction techniques, in order for personal property assets to be accurately identified and segregated.”
What Qualifications are Needed?
Technically there are no qualifications required in order to conduct a study. The IRS, as previously shown, prefers “professionally” based studies but makes no requirements for such. This is why it is highly important that a professional accounting firm of CPAs partner with an engineering firm in order to deliver a defensible report. This also insulates the CPA from professional liability.
What Documentation is Desired?
• Construction drawings• Construction invoices• AIA G702 & G703
– Master & itemized sub-contractor’s invoices
• Closing documents or lease agreement– Appraisal to be included
• General Ledger Account Summary• Current Fixed Asset Schedule• At a minimum we need the FAS
– A CSS is more expensive with no documentation
When Can a CSS be Performed?
• Cost segregation can be performed at any stage of ownership, whether purchased, constructed or leased…– Design phase– Pre-construction– Under construction– Current occupancy back to January 1, 1987
• The best time is prior to construction because our recommendations will increase the short-lived asset basis.
What reports are made to the IRS, and how?
• IRS Form 3115, Application for Change in Accounting Method– Unless asset has not been placed in
service then normal initial filing procedures
• You, as the CPA, or SHL completes the 3115 for the client to file with the IRS
What IRS Tax Code Sectionsare Involved?
• §§ 167, 168– Depreciation rules, GDS, ADS, ACRS, MACRS
• §§ 1245, 1250– Tangible personal property & real property
• Dozens of Revenue Procedures & Rulings• Dozens of PLRs• Publication 946• Multiple AODs
What Minimum Asset Basis does Cost Segregation Make Sense?
• QLIs (Qualified Leasehold Improvements) will generally qualify at $100,000+
• QRPs (Qualified Restaurant Property) will generally qualify at $75,000+
• Office condos typically qualify at $150,000
• Free-standing buildings will vary wildly due to the industry and build-out variances, but generally $150,000+/- will work.
How do the new “Repair & Maintenance” rules impact cost segregation studies, if at all?
• Depreciation consistency rule: cost segregation studies. If a taxpayer properly changes the MACRS class or depreciation method for any type of property in a year after the property was placed in service, the taxpayer must change the unit of property to be consistent with the change for depreciation purposes. For example, if a taxpayer performs a cost segregation study on building components and changes their classification from 1250 to 1245 property, the taxpayer must use the same classifications to define the unit of property for capitalization purposes.– In essence, no impact for properly performed studies.– http://www.bakertilly.com/IRS-Issues-New-Repair-Maintenance-Regulations
How do the new “Repair & Capitalization” rules impact cost segregation studies, if at all?
• Clients should begin booking assets in a different format as they implement the new regulations. The change we will see is that instead of booking (3) assets (Land, Building, & Land improvements) that the building and land improvements will be booked in and broken down into far greater detail, component by component. We already do this on many new construction projects. Acquisitions will have to be more detailed in the future.
• The opportunity for Cost Seg providers is that we are the qualified professionals who can most easily and accurately provide that greater level of detail, especially for the acquisitions. We foresee the studies becoming slightly more time consuming because every project should be broken down into as much detail as we can reasonably provide without getting carried away.
• In summary, Cost Seg studies will be even more relevant than before because we will now provide a two-fold benefit, accelerated depreciation and componentization to meet the new regulatory requirements.
• Taxpayer compliance began January 1, 2014.
“Repair & Capitalization” rules 2
• Additionally, some of the hidden tax benefits for taxpayers that were highlighted at the AICPA conference include:– Segregating the cost of structural components of
buildings that were disposed of in prior years– Identifying expenditures in prior years or current years
that do not constitute improvements to buildings or building systems and can be expensed as repairs
– Reviewing the results of a prior year cost segregation study to identify dispositions of 1245 property
– Identifying the cost of removal of a structural component not subject to capitalization under 263A
– To segregate the cost of the eight building systems for purposes of applying the improvement and disposition rules under the final regulations
“Repair & Capitalization” rules 3• How are expenditures treated?
– When capitalizing expenditures, the amounts paid fall into one of two categories:
• Amounts paid to acquire or produce tangible property, or• Amounts paid to improve tangible property.
• Generally capitalized costs include invoice price, transaction costs, and costs for work performed prior to the date the property is placed in service by the taxpayer. If the taxpayer is improving or “bettering” the real or personal property amounts that must be capitalized include correcting a material defect of the property, physical enlargement, expansion, or a material increase in capacity, productivity, or efficiency of the property. A taxpayer must capitalize costs that restore a unit of property to like new condition after the end of its class life. Costs incurred to adapt a unit of property to a new or different use must also be capitalized.
I want a "cookbook approach" of how & when to use Cost Segregation!
Early – Often – Always!• Is your client paying income taxes?
– If so, what tax bracket? Subject to AMT?
• Will your client own/lease at least 3 years?• Is there a NPO occupying 50.1% or more of
the building? If so, it doesn’t qualify.• Do they meet the minimum asset values?
– $75k - $100k QRPs/QLIs or $150k for buildings
Are there new opportunities available for a cost segregation study under the new regulations?
• Short answer…YES!– New acquisitions or construction– Building expansion– Capital improvements
• In summary, cost segregation studies will be more relevant than before because a CSS will now provide a two-fold benefit…accelerated depreciation and componentization to meet the new regulatory requirements.– A side benefit is the detailed substantiation
for insurance claims due to fire, water damage, etc.
What are the steps involved in the CSS process?
• Engage a reputable Cost Segregation firm• The engineer determines what documents are
available & what must be recreated• Time is scheduled into the Cost Segregation
process for document recreation• The engineer then sets a schedule for surveying
the subject property• The site survey is executed and completed• The number crunching process begins• A review committee then examines the results of
the analysis• The study results are compiled into a final report and
issued• Start to finish…4 to 6 weeks
What qualifications should be considered in hiring a cost segregation firm?
• Does the Cost Seg firm use the accounting based approach, the engineering based approach or a combination of both?1
• Construction experience?2
• Cost Segregation experience?3
• Estimating experience?4
• Project complexity.5
• IRS Cost Segregation Audit Techniques Guide.6
• IRS audit track record.7
• Bonus Depreciation/QLI/QRP knowledge and experience.8
1Accounting, Engineering or both?• Accounting based studies strictly use construction project costs
as provided to them by the contractor, sub-contractors, other project invoices, and general ledger activity. They use only accounting based methods to identify and segregate property. These firms are not capable of performing engineering based take-offs that provide a higher level of benefit. No site visit is performed.
• Engineering based studies use only the construction plans & contracts, sub-contracts, invoicing, and quantity take-offs. They do not work with accountants to include out-of-pocket expenses that need to be included in the study. They rely primarily on the construction plans and site visits to perform take-off estimates for most or all assets.
• Combination based studies use both accounting & engineering methods to assemble the most complete and accurate study possible. Engineers & construction professionals complete the studies and consult with the CPA and owner accounting professionals to ensure studies are meeting the requirements set forth by the IRS CS Audit Techniques Guide.
2Construction, 3Cost Segregation and 4Estimating Experience
• 2Does the firm employ persons having practical commercial construction experience or training?
• 3Does the firm employ persons with experience at a large national accounting firm? Critical to understanding depreciation methods & conventions, general ledgers, and the proper treatment of the various project-related expenses beyond the general contract.
• 4Thorough understanding and proper use of RS Means and Marshall Valuation Services estimating materials and techniques.
5Project Complexity, 6IRS CSATG
• 5Experience in performing studies of everything from Square Foot analysis of the simplest buildings to new construction of multi-million dollar commercial projects in varied manufacturing and construction environments.
• 6Extensive and practical knowledge of the Cost Segregation Audit Techniques Guide.
7IRS Audit Track Record8Bonus Depreciation, QLIs/QRPs
• 7Provide examples of successfully defended audits, if any audits occurred, whether by individual engineer or the firm
• 8Extensive background in working with and applying bonus depreciation for all applicable years, QLI & QRP calculations per individual year applications
Does Cost Segregation have any additional benefits?
• It can reveal opportunities to reduce real estate tax liabilities and identify certain sales and use tax savings opportunities.– Personal property assessed at a lower rate– Some states grant “sales & use tax”
deductions
• Maximize tax savings by adjusting the timing of deductions.
• Create an audit trail documenting cost and asset classifications.
• Capture retroactive savings with § 481(a).
Inherent Permanency Test
• These criteria included:1. whether the asset is movable or
removable; 2. how the asset is attached to real
property; 3. the design of the asset; and 4. whether the asset bears a load.
The "WHITECO FACTORS"• As summarized by the Tax Court in Whiteco Industries
Inc. [65 T.C. 664 (1975)], the following essential factors were examined to determine whether property was inherently permanent: * Is the property capable of being moved, and has it in fact been moved? * Is the property designed or constructed to remain permanently in place? * Are there circumstances that tend to show the expected or intended length of affixation, i.e., are there circumstances that show that the property may or will have to be moved? * How substantial and time-consuming a job is removal of the property? Is it "readily removable?” * How much damage will the property sustain upon its removal? * What is the manner of affixation of the property to the land?
How can a CPA best work with a cost segregation firm to save time and money for the client and me?• Determine…is the client profitable
and paying federal income taxes; if so…
• Be proactive…ask your client a stupid but necessary question…– Do you want me to minimize your taxes
as much as possible…legally of course?
• Share the current FAS with your cost segregation partner for a benchmark analysis. SHL provides them for free and GUARANTEES the results.
How are cost segregation analyses billed?
• Reputable firms bill on a fixed fee basis based on complexity, asset size, industry, available documentation, and location.– Example: A 100,000sf warehouse would be
considerably cheaper than a 100,000sf telecommunications center.
– Most collect ½ of the fee at engagement and the remainder at delivery of the final report results.
– Beware any mention of contingency as this is covered under Circular 230 and all those practicing before the IRS are banned from it.
Share a case study from a recent Cost Segregation engagement
In a Nutshell…
• Cost segregation is a tool that accomplishes many things…– Increased cash flow for your clients– Operating budget reduction = higher
profitability– Places client in IRC Tax Compliance– Adds tremendous value to your services– Gives you a competitive edge over
competition– Happier clients remain your clients
• Client retention vs. Client acquisition
Thank You!
2150 S. Central Expy, Ste. 200, McKinney, TX 75070
www.SegregationHolding.comwww.SegregationHoldingLimited.com 972-865-9050 Office / 972-865-9626
Facsimile972-897-8019 Jeff’s Cell
[email protected] 269-303-0810 Brian’s Cell
Cost Segregation Links•MACRS = http://www.irs.gov/Businesses/Cost-Segregation-Audit-Techniques-Guide---Chapter-2---Legal-Framework#6 •Section 1245 & 1250 = http://www.irs.gov/Businesses/Cost-Segregation-Audit-Techniques-Guide---Chapter-2---Legal-Framework#12 •What is tangible personal property? = http://www.irs.gov/Businesses/Cost-Segregation-Audit-Techniques-Guide---Chapter-2---Legal-Framework#8 •Tangible Personal Property = http://www.irs.gov/Businesses/Cost-Segregation-Audit-Techniques-Guide---Chapter-2---Legal-Framework#10 •What is the Investment Tax Credit §68? = http://www.irs.gov/Businesses/Cost-Segregation-Audit-Techniques-Guide---Chapter-2---Legal-Framework#9 •Building Structural Components = http://www.irs.gov/Businesses/Cost-Segregation-Audit-Techniques-Guide---Chapter-2---Legal-Framework#11 •HCA Ruling = http://www.irs.gov/Businesses/Cost-Segregation-Audit-Techniques-Guide---Chapter-2---Legal-Framework#16 •Chief Counsel Guidance = http://www.irs.gov/Businesses/Cost-Segregation-Audit-Techniques-Guide---Chapter-2---Legal-Framework#18 •No Bright-Line Test = http://www.irs.gov/Businesses/Cost-Segregation-Audit-Techniques-Guide---Chapter-2---Legal-Framework#19•Component Depreciation = http://www.irs.gov/Businesses/Cost-Segregation-Audit-Techniques-Guide---Chapter-2---Legal-Framework#3 •Bonus Depreciation 2008 = http://www.irs.gov/Businesses/Cost-Segregation-Audit-Techniques-Guide---Chapter-2---Legal-Framework#7 •Change in Accounting Method = http://www.irs.gov/Businesses/Cost-Segregation-ATG---Chapter-6.2-Change-in-Accounting-Method •Cost Segregation Methodologies = http://www.irs.gov/Businesses/Cost-Segregation-Audit-Techniques-Guide---Chapter-3---Cost-Segregation-Methodologies •Detailed Engineering Approach = http://www.irs.gov/Businesses/Cost-Segregation-Audit-Techniques-Guide---Chapter-3---Cost-Segregation-Methodologies#5 •What Methodology is Required by the IRS? = http://www.irs.gov/Businesses/Cost-Segregation-Audit-Techniques-Guide---Chapter-3---Cost-Segregation-Methodologies#11 •Principal Elements of a Quality CSS = http://www.irs.gov/Businesses/Cost-Segregation-Audit-Technique-Guide---Chapter-4---Principal-Elements-of-a-Quality-Cost-Segregation-Study-and-Report •Preparation by an industry expert = http://www.irs.gov/Businesses/Cost-Segregation-Audit-Technique-Guide---Chapter-4---Principal-Elements-of-a-Quality-Cost-Segregation-Study-and-Report#4 •What is a quality cost segregation report? = http://www.irs.gov/Businesses/Cost-Segregation-Audit-Technique-Guide---Chapter-4---Principal-Elements-of-a-Quality-Cost-Segregation-Study-and-Report#2 •Repeal of ITC & Component Depreciation = http://www.irs.gov/Businesses/Cost-Segregation-Audit-Techniques-Guide---Chapter-2---Legal-Framework#15 •Depreciation Overview Chapter 6.3 = http://www.irs.gov/Businesses/Cost-Segregation-ATG---Chapter-6.3-Depreciation-Overview •IRC Section 481(a) = http://www.journalofaccountancy.com/Issues/1998/Apr/grimes.htm •Rec. Proc. 2004-11 (Automatic Consent Procedure) = http://www.irs.gov/irb/2004-03_IRB/ar11.html •CSATG = http://www.irs.gov/Businesses/Cost-Segregation-Audit-Techniques-Guide---Table-of-Contents •Depreciation Recapture = http://www.irs.gov/publications/p544/ch03.html#en_US_publink100072560 •Form 3115 = https://www.dropbox.com/s/13kl2n2dxvgd5yl/IRS%20Form%203115.pdf •IRS Case Studies = http://www.irs.gov/Businesses/Cost-Segregation-ATG---Chapter-6.4-Relevant-Court-Cases •Residential Rental Property Depreciation = http://www.irs.gov/publications/p527/ch02.html#en_US_2012_publink1000219045 •How to determine which MACRS method applies = http://www.irs.gov/publications/p527/ch02.html#en_US_2012_publink1000219071 •Publication 527 (2012), Residential Rental Property = http://www.irs.gov/publications/p527/index.html •ERTA 1981 = http://en.wikipedia.org/wiki/Economic_Recovery_Tax_Act_of_1981•Cost Segregation Relevant Court Cases = http://www.irs.gov/Businesses/Cost-Segregation-ATG---Chapter-6.4-Relevant-Court-Cases •Depreciation Overview = http://www.irs.gov/Businesses/Cost-Segregation-ATG---Chapter-6.3-Depreciation-Overview •CSS Specific Guidance for Restaurants = http://www.irs.gov/Businesses/Cost-Segregation-Guide---Chapter-7.2-Industry-Specific-Guidance---Restaurants •IRS Form 3115 = https://www.dropbox.com/s/qpyfwx1n941nsn3/IRS%20Form%203115.pdf •Publication 946 – Bonus Depreciation = www.irs.gov/publications/p946/ch03.html •Repairs & Capitalization = http://www.irs.gov/irb/2012-14_IRB/ar05.html •Baker Tilly Presentation in PDF = https://www.dropbox.com/s/dso1dsfsydve6jx/Baker%20Tilly%20Repair%20%26%20Maintenance%20Tax%20Webinar.pdf