There are several ways that a cost segregation specialist can assist the tax professional to ensure that their clients are in compliance with and benefit from the 2014 Tangible Property Regulations (TPRs) going forward in 2015.
The first is to obtain a traditional engineering based cost segregation study with the proper detail that spells out the various building systems.
A traditional engineering based cost segregation study is an analysis generally performed by an independent third party that reclassifies or segregates real estate components and improvements between real and personal property in order to accelerate the depreciation periods from 39 or 27.5 years to 15, 7, or 5 years. By breaking down the various component parts/systems of building improvements, and reclassifying them into shorter lives, near term depreciation is increased, federal income taxes are reduced and the after tax return on the owner’s investment is increased.
The new repair regulations (2014 Tangible Property Regulations) change the unit of property to be considered from a property level to a building level meaning that each building must be treated separately on a depreciation schedule. For example, no longer would a multifamily apartment project be considered a unit of property but with the new regulations, each building within the project must be accounted for separately.
In addition, The IRS website regarding complying with the new repair regs states:
“For buildings – The unit of property is generally the entire building including its structural components. However, under the final regulations and for these purposes only, the improvement analysis applies to the building structure and each of the key building systems. The key building systems are the plumbing system, electrical system, HVAC system, elevator system, escalator system, fire protection and alarm system, gas distribution system, and the security system. Lessees of portions of buildings apply the analysis to the portion of the building structure and portion of each building system subject to the lease. Lessors of an entire building apply the improvement rules to the entire building structure and each of the key building systems.”
Why is a breakdown of building systems necessary within a building?
One of the primary objectives of the new repair regulations was to develop guidelines to determine whether an expenditure is an expense or must be capitalized. The first criteria to be applied is whether the expenditure is a betterment, adaptation or restoration sometimes referred to as the BAR test. If the expenditure meets the BAR test then it must be capitalized.
If the expenditure is not a betterment, adaptation or restoration, then the next criteria to be considered is the comparison of the expenditure to the total value of the system. Thus to be able to determine whether an expenditure can be expensed, the taxpayer/tax preparer needs to know the value of the key building system. Based on the examples provided by the IRS, if the expenditure exceeds 30% to 40% of the value of the system, then the expenditure must be capitalized.
So a traditional cost segregation study not only can save/defer taxes for the taxpayer but it also provides the necessary detail to determine whether an expenditure can be expensed or capitalized.
What happens if the client has had a cost segregation study done but the report does not provide the detail necessary to determine the value of the building system? In this case, a systems valuation study can be done at a reduced cost to provide the information necessary to make the capital versus expense decision.
Another area that the cost segregation specialist can assist in is determining the value of a component that has been replaced or removed, referred to as a partial disposition election. While the IRS in tax year 2014 allowed taxpayers to go back retroactively and deduct the value of the remaining depreciation on an item removed, beginning in 2015, taxpayers must take the deduction only in the year that it occurs. In cases where a cost segregation study has not been previously performed, a cost segregation specialist can determine the value of the component part in order to quantify the amount of the “write off”.
And finally, the new repair regulations allow a taxpayer to go back and reclassify an expenditure from a capital item to an expense if justified by the new regulations. A cost segregation specialist can evaluate an expenditure and determine whether it meets the BAR test. If it does not, then the expenditure can then be compared to the value of the system to determine whether it can be reclassified as an expense.
In summary, your cost segregation specialist can be a cost effective, value added consultant to the tax professional. Take advantage of the consultant’s knowledge and experience as well as their engineering expertise. At no cost to the taxpayer or the tax professional, a cost segregation specialist can review a taxpayer’s depreciation schedule and can provide recommendations of how to save the taxpayer the maximum amount of money and ensure full compliance with the 2014 Tangible Property Regulations.
David H. Trahan, MBA is a senior consultant/account representative with Cost Segregation Services Inc.(CSSI), one of the premier cost segregation firms in the US. CSSI has been saving clients money over the last 14 years and has completed over 14,000 cost segregation studies. David has been providing commercial real estate clients real estate consulting services for 42 years as a real estate broker, property tax consultant and a licensed appraiser and has offices in Texas and North Carolina.
David is available for consultation at firstname.lastname@example.org or via phone at 832.971.2885.