CohnReznick is an independent

member of Nexia International

Presented by: Richard Shevak and

Derek Weaver

C o s t S e g r e g a t i o n a n d Ta n g i b l e

P r o p e r t y R e g u l a t i o n s U p d a t e –

P r e p a r i n g f o r I R S E x a m i n a t i o n s

P U R P O S E

1

The purpose of this course is to provide updates in connection with IRS

guidance and examination activity in connection with cost segregation and

other fixed asset studies. Additionally, we will discuss several technical issues

that could create examination risk if not dealt with properly.

January 11, 2017

A G E N D A

2

Audit Techniques Guide for Tangible Property Regulations

Audit Techniques Guide for Cost Segregation

AmeriSouth Case Discussion

Other Technical Issues

Bonus Depreciation and §179 Update

January 11, 2017

B E F O R E W E B E G I N …

3

What are the Tangible Property Regulations?

–Repair issues

–Acquisition cost issues

–Materials and supplies

–Dispositions

What is a Tangible Property Regulations Study?

What is a cost segregation study?

January 11, 2017

A u d i t Te c h n i q u e s G u i d e ( AT G ) f o r

Ta n g i b l e P r o p e r t y R e g u l a t i o n s

( T P R )

TA N G I B L E P R O P E R T Y

R E G U L AT I O N S H I S T O R Y

5

Several prior versions of the regulations.

–Before the final regulations, many taxpayers were filing Forms 3115

based on prior case law.

Final Regulations: Effective tax years beginning on or after 1/1/2014.

January 11, 2017

I R S A U D I T T E C H N I Q U E S G U I D E

6

September 14, 2016 – IRS released an Audit Technical Guide related

to the Tangible Property Regulations (TPR).

Provides specific guidance for IRS examiners to identify potential tax

issues related to capitalization and dispositions of tangible property.

Almost 200 pages long with 18 chapters; each chapter contains a

summary of the law and is followed by “Audit Procedures.”

The Audit Procedures contain questions to be asked by the IRS

agent, facts to consider, and information to be requested by the

agent.

January 11, 2017

I R S A U D I T T E C H N I Q U E S G U I D E ( c o n t . )

7

“General” chapter instructs IRS agents to ask if the taxpayer

performed a prior TPR study. If so, the agents are asked to consider:

–Years affected by the study.

–Assets affected by the study.

–How the taxpayer determined which assets to analyze (i.e., did the

taxpayer “cherry-pick”?).

–Did the taxpayer properly define units of property (UOP)?

– Information (support) considered when performing the analysis.

Note: Insufficient information may cause the IRS to deny certain

deductions.

–Computation of Schedule M adjustments (book/tax differences).

January 11, 2017

A U D I T T E C H N I Q U E S G U I D E

H I G H L I G H T S

8

Unit of Property Change

Did the taxpayer properly apply the UOP rules?

–Did the taxpayer analyze the building expense on a “system by

system” basis?

Did the IRS agent specifically consider any Section 481(a)

adjustment?

–The IRS will check to make sure you reduced the basis in your

depreciable assets and are not “double-dipping.”

Did the IRS agent determine the type of property that would be

impacted by the change?

January 11, 2017

A U D I T T E C H N I Q U E S G U I D E

H I G H L I G H T S ( c o n t . )

9

Amounts Paid To Acquire Or Produce Property

Are there any capitalizable indirect acquisition or costs that the

taxpayer deducted?

–Acquired assets: Did the taxpayer capitalize the list of facilitative

costs contained in the regulations?

–Produced assets: Did the taxpayer properly apply 263A?

Improvement Rules (Betterment, Restoration, New, Or Different

Use)

Did the taxpayer perform its TPR analysis in accordance with the final

regulations?

–Did the taxpayer apply all of the appropriate tests?

–Betterment, Restoration, New, or Different Use

January 11, 2017

A U D I T T E C H N I Q U E S G U I D E

H I G H L I G H T S ( c o n t . )

10

De Minimis Safe Harbor

Does the taxpayer have an applicable financial statement?

If so, did it have a written policy in place as of the first day of the tax

year?

Does the company actually follow that policy (Consistency)?

Did the taxpayer properly identify the asset to which it applied de

minimis? (Example: If you received two invoices for a single asset

that were each under the de minimis threshold, but were more – in

total – than the de minimis limit.)

Routine Maintenance Safe Harbor (RMSH)

Did the taxpayer apply the RMSH appropriately?

–Did it apply the RMSH to property that was improved or adapted to

a new or different use?

January 11, 2017

A U D I T T E C H N I Q U E S G U I D E

H I G H L I G H T S ( c o n t . )

11

Leased Property

Does the taxpayer own or lease property?

Was Section 110 properly applied to leased property (related to the

receipt of tenant improvement allowances)?

–The IRS will ask whether the income a tenant received was

recognized as income. If not, they will ask why Section 110 applies

to prevent revenue recognition.

–Book treatment for tenant improvement allowances is typically NOT

appropriate for tax purposes.

January 11, 2017

A U D I T T E C H N I Q U E S G U I D E

H I G H L I G H T S ( c o n t . )

12

Materials and Supplies

How does the taxpayer account for materials and supplies?

–Are they deducted immediately or deducted when “consumed”?

–Are materials and supplies properly defined?

Are materials and supplies (for a producer) properly capitalized to

inventory?

Are materials and supplies actually spare parts related to a piece of

equipment?

Is the taxpayer using the de minimis safe harbor?

January 11, 2017

A U D I T T E C H N I Q U E S G U I D E

H I G H L I G H T S ( c o n t . )

13

Dispositions

Has the taxpayer has performed a “disposition” study?

What is the extent of the study (refer to the engagement letter and

presentation materials)?

Were any basis adjustments recorded on an asset by asset basis?

An IRS agent considers whether the property deducted as a

disposition was actually disposed (similar to an abandonment

analysis).

January 11, 2017

AT G f o r C o s t S e g r e g a t i o n S t u d i e s

O U T L I N E O F AT G

15

8 chapters

Cost Segregation Methodologies: Chapter 3

Principal Elements of a Quality Cost Segregation Study: Chapter 4

Chapter 5 provides suggested audit steps for reviewing and

examining a cost segregation study and report.

Chapters 7 & 8 provide the Industry Specific Guidance and Issue

Specific Guidance.

January 11, 2017

C O S T S E G R E G AT I O N A U D I T

T E C H N I Q U E S G U I D E

16

Assists IRS examiners with review and examination of cost

segregation studies.

Provides IRS examiners with an understanding of:

–Why cost segregation studies are performed for tax purposes;

–How cost segregation studies are prepared;

–What to look for in the review and examination; and,

–When certain issues identified in the study need further

examination.

In some cases, IRS examiners may require specialists with expertise,

industry experience, and specialized training (e.g., engineers,

computer audit specialists, and/or DCE PN Senior Revenue Agents).

January 11, 2017

C O S T S E G R E G AT I O N

E X A M I N AT I O N S T E P S

17

1. Review the cost segregation study report for initial risk analysis

purposes.

2. Verify the cost basis and reconcile depreciation records.

3. Conduct a risk analysis to evaluate audit potential.

4. Review the cost segregation study report for examination purposes.

5. Interview the cost segregation study preparer.

6. Inspect the property.

7. Review and verify the asset classes and recovery periods of

property.

January 11, 2017

C O S T S E G R E G AT I O N

E X A M I N AT I O N S T E P S ( c o n t . )

18

8. Research the law, the regulations, and appropriate rulings.

9. Cost analysis.

10.Summarize the findings and discuss the challenged assets with the

taxpayer.

11.Prepare the final report or the Notice of Proposed Adjustments (if

necessary).

12.Review sampling techniques (if necessary).

13.Consider §263A.

14.Consider change in accounting method.

January 11, 2017

D i s c u s s i o n o f t h e A m e r i S o u t h

C a s e

C A S E F A C T S

20

AmeriSouth XXXII, Ltd. bought an apartment complex in 2003 for $10.25

million.

AmeriSouth claimed on its returns that the water-distribution and

sanitary-sewer systems, the gas lines, and the site electric were eligible

for 15-year depreciation.

AmeriSouth claimed property in the other categories was eligible for 5-

year depreciation.

The taxpayer's argument was challenged by the IRS Commissioner.

AmeriSouth sold the apartment complex before the case made it to trial.

Conclusion:

– Tax Court allowed 5 and 15-year treatment on certain items.

– Tax Court disallowed some 5 and 15-year assets.

Some were disallowed because taxpayer did not present evidence.

Analysis involved whether certain items were “necessary” in a building.

January 11, 2017

O t h e r Te c h n i c a l I s s u e s

C O S T S E G R E G AT I O N S :

R E L I N Q U I S H E D P R O P E R T Y

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Relinquished property: Before a 1031 transaction.

If you performed a cost segregation on a property and THEN use that

property as the relinquished property in a 1031 transaction, you may

have potential recapture issues.

– If the relinquished property has more 1245 than the replacement

property, there will be a recapture issue.

– If the relinquished property has less 1245 property than the

replacement property, then you will not have a recapture issue.

If the relinquished property was the subject of a cost segregation

study, the opportunity here might be to do a cost segregation on the

replacement property to avoid recapture issues.

January 11, 2017

C O S T S E G R E G AT I O N S :

R E P L A C E M E N T P R O P E R T Y

23

Replacement property: After a 1031 exchange.

Application of the rules under §168:

–Exchange basis: General rule

–Exchange basis: Election

–Excess basis: Rule

January 11, 2017

TA X - E X E M P T O W N E R A N D

T E N A N T R U L E S

24

Tax-exempt Owners:

If the entity is owned partially by tax-exempt members, the portion of

ownership related to the tax-exempt owners would have an ADS

depreciation allocation/split for each asset class if you do not have a

qualified allocation.

For example, if a residential rental property is owned 40% by tax-

exempt members, 40% of what would typically be 27.5-year basis

would be depreciated using 40-year ADS. 40% of the personal

property would have an ADS allocation (40% 5/9-year ADS vs. 60%

5-year MACRS). The same would be true for land improvements and

other types of property in the entity.

January 11, 2017

TA X - E X E M P T O W N E R A N D

T E N A N T R U L E S ( c o n t . )

25

Tax-exempt Tenants:

1250 Property: If the tax-exempt tenant occupies 35% or more of the

building and is doing so in a disqualified lease, the 1250 property would

be depreciated using ADS (40-year ADS instead of 39-year MACRS

property).

1245 Property:

– The personal property in tax-exempt tenant space should be

depreciated over the greater of 125% of the tenant’s lease term,

including options to renew or the designated ADS class life for the

property. For example, the ADS class life for office furniture is 10-year

ADS.

– If the tax-exempt tenant’s lease term is 15 years and the tenant has a

5-year renewal option after the initial lease term, the office furniture

should be depreciated over 25 years using ADS straight-line

depreciation (15 year lease term + 5 year option = 20 years x 125% =

25-year ADS).

January 11, 2017

P R O P E R T Y P U R C H A S E D W I T H

T H E I N T E N T T O R E M O D E L

26

If a company or taxpayer purchases a property with an immediate

plan to renovate the property (say in the first year or so), this limits

our ability to identify personal property or disposition basis in the

acquisition cost related to assets removed/demolished as part of the

renovation.

In other words, if a company or taxpayer knew they were retiring or

demolishing property subsequent to purchase, the basis in the

demolished property has very little or no value.

Often, the buyer negotiates a lower purchase price based on the

anticipation of a large spend for a subsequent remodel project.

January 11, 2017

P R O P E R T Y P U R C H A S E D W I T H

T H E I N T E N T T O R E M O D E L ( c o n t . )

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For example, if a company or taxpayer purchased an apartment

complex and they knew they were going to replace all the carpeting

and cabinetry as part of a subsequent remodel project immediately

after purchase, the old carpet and cabinets have little to no value or

depreciable basis at acquisition.

Depending on the extent of the remodel project, it often does not

make sense to perform a cost segregation study on the acquisition

basis. The cost segregation opportunity might then lie with the

subsequent remodel project.

January 11, 2017

B o n u s D e p r e c i a t i o n a n d § 1 7 9

U p d a t e

P r o t e c t i n g A m e r i c a n s f r o m T a x H i k e s A c t

o f 2 0 1 5 ( “ P A T H ” )

PAT H A C T – B O N U S

D E P R E C I AT I O N U P D AT E

29 January 11, 2017

Old Rule

Property with a recovery period

of 20 years or less

Computer software

Water utility property

Qualified leasehold

improvement property

New Rule

Property with a recovery period

of 20 years or less

Computer software

Water utility property

Qualified improvement

property

Extends Bonus Depreciation to

2019

Q U A L I F I E D I M P R O V E M E N T

P R O P E R T Y D E F I N I T I O N

30

Beginning in 2016, “Qualified Improvement Property” replaces

Qualified Leasehold Improvement Property (QLIP) in the list of

bonus-eligible property.

Broader Definition:

–Defined similarly as QLIP, except that the interior improvements do

not need to be made pursuant to a lease, the improvements do not

need to be to tenant space, and there is no 3-year requirement.

Qualified Improvement Property is any improvement to an interior

portion of a building that is nonresidential real property if the

improvement is placed in service after the date the building was first

placed in service, excluding: 1) enlargements; 2)

elevators/escalators; and 3) internal structural framework.

January 11, 2017

B O N U S R AT E S B Y Y E A R S

31 January 11, 2017

PAT H A C T – S E C T I O N 1 7 9

U P D AT E

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The following are made permanent:

$500,000 limit

$2,000,000 phase-out

Ability to use 179 for computer software

Ability to use 179 for qualified real property

– $250k limit (and corresponding carry-forward language) deleted.

Inflation adjustment added

Ability to use 179 for air conditioning and heating units

January 11, 2017

C O S T S E G R E G AT I O N

C O N F E R E N C E TA K E - A W AY S

33

The number of IRS agents tasked with auditing cost segregation

studies has diminished somewhat over the years.

The AmeriSouth case is largely ignored when considering whether to

do a study on residential rental property.

Practitioners are considering the implications of the TPR when

conducting cost segregation studies.

January 11, 2017

Richard Shevak, JD, Director

CohnReznick LLP

4 Becker Farm Road

Roseland, NJ 07068

862.245.5029

Richard.Shevak@CohnReznick.com

Derek Weaver, Senior Manager

CohnReznick LLP

7501 Wisconsin Avenue

Suite 400E

Bethesda, MD 20814

301.280.2727

Derek.Weaver@CohnReznick.com

www.CohnReznick.com