New Tax Law - The Tax Cut and Jobs Act, 12/22/2017 Good News - 100% Bonus Depreciation for 20 years-life segregated property classfication can be allowed for the property placed after September 27, 2017.
Example - Actual Case I Performed
14-Story Office Building
Purchase Price - $37,170,000
Improvements Basis (for Cost Segregation) except Land - $30,985,316
After Cost Segregation
5-year life class - $5,888,901
(19.01% of the improvements basis)
7-year life class - $154,563 (0.50%)
15-year life class - $324,665 (1.05%)
Total eligible for 100% Bonus Depreciation at the first year (5, 7, 15 years class combined) under the new tax law:
If under the old tax law prior to 09/27/2017, apply the double-declining balance method, the first year (5, 7, 15 years class combined), the depreciation will be:
That is the increase of depreciation benefit of $3,935,206 at the first year.
Assuming a tax bracket of 37% for married filing jointly over $600,000, additional tax savings will be $1,456,026 depending on the individual or entity's tax situation.
Take a huge tax deduction by doing the Cost Segregation. Under the alternative depreciation system, as modified by the Act, the recovery periods for nonresidential depreciable real property, residential depreciable real property and qualified improvements are 40 years, 30 years and 20 years, respectively.
The Act extends and modifies the additional first-year depreciation deduction for qualified depreciable personal property by increasing the 50% allowance to 100% for property placed in service after September 27, 2017, and before 2023. After 2022, the bonus depreciation percentage is phased-down to 80% for property placed in service in 2023, 60% for property placed in service in 2024, 40% for property placed in service in 2025, and 20% for property placed in service in 2026. The bill removes the requirement in current law that the original use of qualified property must commence with the taxpayer. Thus, immediate expensing applies to purchases of used as well as new items.
Something called cost segregation may help owners of commercial real estate save significantly on their federal income taxes.
The primary goal of a cost segregation study is to identify all construction-related costs that qualify for accelerated income tax depreciation. Small or large, your business can save money with a cost segregation study, typically many times the amount you invest. The Benefits of Cost Segregation We perform a detailed analysis of your commercial property for the purpose of identifying all of the construction related expenses that can be depreciated over 5, 7 and 15 years. The result of our study is the accelerated depreciation of these deductions, reducing your tax liability and increasing your cash flow.
The Benefits of Cost Segregation (applicable to prior to 09/27/2017)
Cost Segregation is a tax planning tool that determines how quickly an owner should be depreciating the property on his income taxes — five years, seven years, 15 years, 27.5 years or 39 years. The Internal Revenue Service allows owners of commercial properties to accelerate depreciation on their real estate, which will result in reducing the property owner’s taxable income levels. A cost segregation study is an in-depth analysis of the costs incurred to build, acquire or renovate a real estate holding.
Hotel/Motel, Gas Station/ Car Wash, Industrial/ Warehouse Building, Apartment, Office Building, Grocery Store, Restaurant, Retail, Nursing Homes, Golf Course, Auto Related, Leased Tenant Improvements.
Any commercial/investment real property placed into service since January 1st, 1987 may benefit from a Cost Segregation Study (CSS):
Critical timing is when the property was placed into service by the current owner / taxpayer, not when the building was originally constructed.
•New construction, including renovation, remodeling, restoration, or expansion to an existing building
•Property acquired via purchase
•Property acquired via inheritance
•Property which received step-up in basis
•Major leasehold improvements
Certain types of buildings benefit from a CSS more than others. Those are the types of buildings that tend to contain:
•More specialty plumbing, electrical, HVAC system, etc.
•Higher amount and quality of personal property
•Extensive land improvements
Classification from real property to land improvements and personal property: Examples of Qualifying Properties:
» Airports » Apartment Buildings
» Assisted Living Facilities
» Automobile Dealerships
» Bank Branches » Casinos » Cinemas
» Day Care Facilities » Department Stores
» Distribution Centers » Fitness Centers
»Food Processing Facilities
» Funeral Homes » Gas Stations
» Golf Courses » Grocery Stores
» Hospitals » Hotels/Motels
» Industrial Facilities » Laboratories
» Manufacturing Facilities » Marinas
» Medical Centers » Medical Facilities
» Mixed-Use Facilities » Nursing Homes
» Office Buildings » Parking Lots
» Pharmaceutical » Physician Practices
» Public Utilities » Research Facilities
» Retail Centers » Resorts » Restaurants
» Shopping Centers » Sports Facilities
» Storage Facilities » Warehouses
Apartment Buildings 20 - 50%
Office Buildings 10 - 40%
Restaurants 10 - 40%
Hotels 15 - 40%
Light Manufacturing 15 - 40%
Heavy Manufacturing 25 - 70%
Grocery Stores 15 - 50%
Retail Facilities 15 - 40%
Warehouses 8 - 30%
Processing Plants 15 - 40%
R & D Facility 20 - 50%
The building system value, referred to as the unit of property, or UOP, is the reference point from which capitalization decisions are applied. Under the new UOP definition, expenditures relating to each building system must be evaluated as repairs or improvements only with respect to that particular system and not with respect to the entire building.
Taking advantage of cost segregation studies to provide significant tax benefits for their businesses by accelerating the depreciation on qualified fixed assets.
By depreciating the personal property costs of such assets over five or seven years (and land improvements over 15 years instead of the typical 39-year recovery period for general building property), the additional deductions can be used to offset taxable income. This accelerated depreciation, in turn, provides additional cash flow.
More specifically, the new IRS rules made significant changes in the way companies deducted repairs and asset dispositions by setting more defined guidelines for what assets a business can expense and what assets can be capitalized.
The determining factor of what defines a repair expense versus a capitalized improvement cost now lies in a case-by-case analysis of the scenario requiring the expenditure, rather than a review of the overall costs incurred. In most cases, the tax benefits resulting from expensing versus capitalizing are significant. The difference means a company is able to take an immediate deduction of the full remaining asset basis versus an incremental deduction spread out over many years.
According to the new regulations, any expenditure resulting in the “betterment” of the facility must be capitalized. That means any costs simply relating to keeping the property in an ordinary operating condition or restoring it to the same condition when it was placed in service can be expensed.
Any time the expenditure creates a material increase in strength, capacity, productivity, efficiency, quality or output, those costs should be capitalized as a “betterment.” Some examples of repairs that may potentially qualify as an immediate expense would be roof membrane replacements, new HVAC system components and a “refresh” office remodeling where only the finishes are replaced.
In the past, cost segregation studies were used solely to break out the personal property and land improvement costs from the overall building construction or acquisition costs. The unit of property was generally the entire building, including the structural components. However, in the final IRS regulations, the improvement analysis requires businesses to segregate their real property building costs into the building structure along with eight additional defined building systems:
Heating, ventilation and air conditioning (HVAC) system;
• Electrical system;
• Plumbing system;
• Gas distribution system;
• Fire protection & alarm;
• Security system
The challenge for taxpayers seeking to take advantage of this change is clear: to benefit from these dispositions, they must develop a consistent and accepted method for placing a value on individual real property assets, which had previously been lumped into the 39-year “building” recovery period. A cost segregation study, when performed by qualified professionals, can break out real property assets into various additional categories to allow companies to write-off capitalized repairs and maintenance costs in future years.
In addition to the eight additional UOP systems required by the repair regs, additional levels of real property can be broken out for future retirement identification purposes. For example, a new hotel property might request to have their carpeting, light fixtures and bathroom tile by floor. In this way, if the hotel undergoes a remodeling of certain floors and that property is disposed at a later date, the owner will benefit from defined and accepted values for each those components.
Each building and its structural components is a separate unit-of-property. In determining whether an expenditure is an improvement, the taxpayer must consider the effect of the expenditure on the building structure itself and on certain specifically defined components of the building (the "building systems"). Each of the following "building systems" is defined as a separate unit-of-property:
The ultimate result of the regulations is to reduce the size of the unit-of-property which increases the likelihood that an expenditure will need to be capitalized as an improvement. For example, if a taxpayer had an expenditure related to its building roof, the unit-of-property to use in determining if it is a capitalized improvement or a deductible repair is the building since the roof is not included in one of the separate building systems.
For an expenditure to repair several of the building's rooftop air conditioner units, however, the appropriate unit-of-property to use in determining if it is a capitalized improvement or a deductible repair is the HVAC system (a smaller unit-of-property than the building) since the HVAC system is one of the specifically defined building systems.
Most taxpayers have previously treated the entire building as the unit-of-property. With the addition of these new regulations, most taxpayers that own buildings will need to make an accounting method change to adopt the new definition of unit-of-property as it relates to buildings.
Under the new tax law (effective as of 01/01/2018) non-structural assets installed to the interior of a building after the building is originally placed in service are considered Qualified Improvement Property, or QIP. The intent of the law these assets were supposed to be considered bonus depreciation eligible.
In most cases, renovation project improvements expands not only interior improvements, but also other building component systems such as exterior facades, HVAC systems, Elevators, Escalators, load bearing walls, etc. A cost segregation study may be necessary to break out the assets that are not QIP. Without an analysis to break apart the QIP from the remaining assets a taxpayer will not be able to maximize the bonus eligible property.
Additionally if a renovation is combined with an expansion, a study will be required to separate the assets included in the expansion from the assets in the original space. When a taxpayer completes a renovation a discussion should be had with a trusted professional to determine if a study is necessary to determine the amount of QIP.
The Tangible Property Regulations (also known as Repair Regulations) are the largest change to US Tax Law in 30 years and affect every building owner in America. The final regulations provide a general framework for distinguishing capital expenditures from supplies, repairs, maintenance, and other deductible business expenses.
Building owners and their tax professionals now have strict guidelines as to what stays on a fixed asset schedule and what must come off. Not only must every building owner in America follow and apply these regulations to their accounting practices, but there may be a financial upside to doing so. Our Cost Segregation Study reviews the regulations to assist with compliance along with the financial benefit.
We provides the necessary calculations for business owners to apply the Tangible Property Regulations; this is coordinated with your tax professional.
When a taxpayer makes an improvement to a unit of property, the project often includes demolishing or removing a portion of the property. A write-down can be taken on the items removed from the building, but this must be done in the year the items were removed. We provide the calculation for Partial Asset Dispositions when business owners make improvements to their buildings.
A taxpayer who has made the Partial Asset Disposition election can also deduct the costs of a project associated with removing and disposing components of the building. This write-down would be done instead of capitalizing these costs with the improvement costs, but it also must be done in the year of the disposition deduction. We provide the calculation for Removal and Disposal Cost which occurs when improvements are made to buildings.
Have you replaced items in your building in the past? Replaced a roof or parts of a roof? Replaced HVAC equipment or completed entire renovation(s) to your building? The new Repair Regulations state that there be no “ghost assets” on your fixed asset schedule. Our Cost Segregation Study will find duplicate items that are currently being depreciated and identify them, along with their value, for a write-down. We provide an analysis for the calculations to be applied for historical capital assets that may now be reversed to expense.
The IRS has formally approved the ability to dispose of the remaining cost basis of assets previously retired, replaced, or demolished. This is outlined in the Tangible Property Regulations (IRC §1.168 (i)-8) and can be a tremendous vehicle for tax savings.
Our process includes a review of the existing depreciation schedules, demolition drawings, and other pertinent information. The team also assesses the scope of recently completed capital work to determine the potential for disposition. When this review identifies assets ripe for disposition—but does not warrant a Standard Cost Segregation Study—we suggest our Partial Asset Disposition (PAD) Analysis.
As defined in the Tangible Property Regulations, a PAD Analysis may be conducted in one of three ways:
The outcome of our PAD Analysis is a report that quantifies and presents the value of dispositions, outlines when the assets were placed into and taken out of service, and describes the asset(s) in question. With this information, the client may determine the remaining depreciable basis to support a Partial Asset Disposition election.
A PAD Analysis can also be used to update existing Unit of Property values.
As with most all strategies identified in the Tangible Property Regulations, the benefit of this effort is determined by each project’s facts and circumstances.
Taxpayers can realize significant benefits from the Tangible Property Repair (TPR) regulations by identifying building components that have been replaced or demolished in current or prior years and claiming retirement loss deductions. However, it is often difficult to determine the tax basis of each component without a cost segregation study. While the IRS agrees that a cost segregation study can be used for this purpose, they also allow the “PPI discounting approach” that our calculator utilizes. For more information on the IRS rules related to the PPI discounting approach, see T.D. 9689 Guidance Regarding Dispositions of Tangible Depreciable Property.
Copyright © 2017 Alpha Consulting Group, Certified M&A Advisor (CM&AA), Commercial Business Valuation, Cost Segregation Study, Reserve Study - All Rights Reserved. Business Financial Commercial Valuation, Commercial Real Estate Appraisal, Capital Assets Valuation - Washington State Certified General Real Estate Appraiser, David Hahn, WA Designated Real Estate Broker, Company Business Valuation, Fairness Opinion, Solvency Opinion, Estate Tax Valuation, Gift Tax Valuation, ESOP Valuation, Patent Valuation, IP Valuation, - All Rights Reserved. David Hahn, Certified Valuation Analyst (CVA), Certified Commercial Investment Member (CCIM), Master Analyst in Financial Forensics (MAFF), Accredited Senior Appraiser (ASA).