Review of Section 179 Expensing and Bonus Depreciation of the Small Business Jobs Act of 2010 (HR 5297)
The act increased the maximum amount a taxpayer may expense under IRC 179 to $500,000 versus $250,000 for 2009. Additionally, it increases the phase-out threshold amount to $2,000,000 for tax years beginning in 2010 and 2011.
Moreover, the bill extended first-year 50% Bonus Depreciation available under IRC 168(k) to apply to property acquired and placed in service in 2010. Thus allowing taxpayers the ability to deduct 50% of the depreciation for new assets placed in service in 2010. Effective September 9, 2010 taxpayers are allowed 100% bonus depreciation through The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010.
Increase The Cash Flow of Your Apartment Building
The market conditions in the Apartment Industry continue to improve and remain strong. According the NMHC (http://www.nmhc.org/Content/ServeContent.cfm?ContentItemID=5757), markets are tighter, sales volume is up and financing is more available. Many apartment owners have increased profitability from the lower vacancies/higher rents. With increased profitability, comes increased tax liabilities. Engineering Based Cost Segregation can help apartment owners decrease their tax burden, increase their cashflow and maximize the return on their investment.
Here is a summary of the results for a cost segregation study on a 150 Unit Apartment complex:
This 5 building, 150 unit garden style apartment complex contains 109,654 square feet of gross building area and is situated on a 5.51 acre site. The property was purchased in 2008 for $5,525,000 of which $828,750 was allocated to land. In addition, a major renovation totaling $1,518,220 was completed in 2008 and was included the study. A significant portion of the improvements qualified for 50% bonus depreciation.
Client Benefits:
|
Tax Year |
Additional Depreciation |
Cash Benefit |
|
2009 |
692,973 |
277,189 |
|
2010 |
403,458 |
161,383 |
|
2011 |
221,390 |
88,556 |
|
2012 |
111,005 |
44,402 |
|
2013 |
107,917 |
43,167 |
|
2014 |
24,923 |
9,969 |
|
Total Years 1 – 6 |
$1,551,665 |
$624,666 |
| Fees & Return On Investment | |
| Total Professional Fees | $13,500 |
| NET After Tax Fees | $8,100 |
| Return On Investment | 71.1 : 1 |
This sample is based upon actual results of a completed study. The benefit numbers are based upon a federal income tax rate of 40%. Although the sample depicts a specific type of property, actual results may vary.
The Majority of Cost Segregation Providers Claim to be using some form of Engineeering Approach.
The IRS recommended approach to cost segregation is the Engineering Approach. Most cost segregation companies claim to be using some form of Engineering Approach; however, the majority of them are actually providing an Abbreviated version known as a Residual Study. While they may use Engineering methods to identify and assign costs to the short life assets, they then simply lump the remaining balance into the long life “Real Property” category. Often times, these studies will leave out many items that should be reclassified, resulting in lost benefits to the property owner. The study may even over estimate the amount of personal property, leaving the owner open to increased scrutiny and risk in the event of an IRS audit. What’s more is that these Residual providers are typically charging between 75-120% of a true Engineering Based Cost Segregation Study even though their short-cut approach takes significantly less work.
What is meant by a True Engineering Based Cost Segregation Study?
We conduct our studies using true Engineering-Based Methodology. A true Engineering Based Study or Report will have as much detail for the remaining long life assets as it does for the short life assets. This means that every asset in a property is assigned both a depreciable life and a project cost. All short life AND long life assets are reconciled and accounted for. The property owner will receive the greatest tax benefit with the comfort of knowing that the study is fully supported. Each and every study we produce has all of the necessary detail, documentation and supporting work-papers to stand on their own. However, in the event of an IRS audit and/or if any questions are raised, we will defend our studies at no additional cost. We will even cover any necessary travel costs.
In addition to receiving the greatest immediate tax benefit from a true Engineering Based Study, the property owner can also take advantage of the ability to write off long life assets in the years following the study. If a long life asset such as a roof or air-conditioning unit needs to be replaced in the next 39 years, the owner can write off the remaining depreciable balance of that component all in the same year. This can amount to tens, or hundreds, of thousands of dollars in tax benefits that would otherwise be lost.
The Difference is In the Details
Before deciding on a provider, ask to see a sample of their final report. Check the 39 or 27.5 year detail. How many line items do you see? A true Engineering Based Cost Segregation Study will provide hundreds or thousands of line items detailing the building’s components.
In-House Cost Segregation Studies
A Cost Segregation Study performed In-House, by employees of the company, is often times reviewed with more scrutiny by the IRS. Here is the summary of the Boddie-Noell Enterprises court case:
- The Company owned and operated approximately 240 Hardees restaurants.
- The two employees who conducted the original cost segregation study used an estimate of a existing study conducted by Hardee’s Food Systems which indicated 24% of the assets qualified for ITC. They sent questionnaires regarding costs to contractors but didn’t keep those records.
- The IRS examined the methodology and threw out the results of the study.
- The company took it to court and hired an individual cost segregation practitioner to conduct studies on 7 properties prior to trial.
- The practitioner did not visit any of the sites.
- Indirect costs were improperly allocated to the estimated take offs (i.e. the allocation of excavation and other site work to electrical, HVAC, etc.)
- Some costs were taken from estimating books others were randomly assigned or adjusted from the estimating books.
- After examining the methodology the court stated, “The methodology employed by plaintiff…. was at best, unusual.” They also stated that the results of the 7 studies performed by the individual cost segregation practitioner appeared to be “based on after-the-fact speculations”. The court also found a lack of contemporaneous evidence supporting the corporations’ claims.
A couple of other important points from this case:
- The court found that the suspended ceilings did not qualify as a short life component.
- The external orange roof panels specific to Hardees design did not qualify as a short life component.
- HVAC did not qualify as a short life component.
- Drive up window units did not qualify a short life component.
Cost Segregation studies should not be taken lightly. With the issuance of the IRS Cost Segregation Audit Techniques Guide in 2004, it shows that the IRS knows what separates a good study from poor one. A study conducted by an independent firm is looked at more favorably than one conducted “in-house”. However, it is not safe to assume that any independent cost segregation provider will do.
You can read about the most common cost segregation methodologies here: http://www.irs.gov/businesses/article/0,,id=135052,00.html.
Before deciding on a provider, we recommend that you ask to see a sample of their study so you can compare the methodology used and the level of detail provided.
Tax Planning & Cost Segregation
If you have a client that owns Commercial or Residential Rental property that is currently profitable, or was profitable within the last five years, a properly performed engineering based cost segregation study could help reduce their current tax burden or help them qualify for a tax refund. We can provide a free initial evaluation for the property that you can use to assist them with year end tax planning strategies.
CLICK HERE if you have an interest in getting a Free, No Cost, No Obligation Proposal for a Client.
How Does a Cost Segregation Study (CSS) Work?
Typically Building costs are generally classified for federal income tax purposes into three categories. Each has a different depreciation recovery period and method under the Modified Accelerated Cost Recovery System (“MACRS”):
TANGIBLE PERSONAL PROPERTY
Depreciates Over 5 OR 7 YEARS
At a 200% Declining Balance
LAND IMPROVEMENTS
Depreciate Over 15 YEARS
At a 150% Declining Balance
RESIDENTIAL RENTAL – REAL PROPERTY
Depreciates Over 27.5 YEARS
Straight Line (Residential)
COMMERCIAL – REAL PROPERTY
Depreciates Over 39 YEARS
Straight Line (Commercial)
In most cases, when a property is placed in service, the straight line method is used. In some cases, the obvious short life items are separated out and the remainder depreciates over the long term straight line method.
By reclassifying components from 39 year real property (subject to straight line) to five or seven year personal property (qualifying for 200% Declining Balance), the recovery period is greatly compressed. In addition to the reduction in the recovery period, all five and seven year property is depreciated at a 200% declining balance which further accelerates the depreciation. This provides the building owner the ability to greatly increase the depreciation for a property and thus significantly reduces the building owners taxable income and current income tax liabilities.
Our Engineering Based Cost Segregation Study will help identify items that should be properly classified as tangible personal property or land improvements, rather than real property that is depreciated over 39 years. The tax benefits begin in the first tax year and continue throughout the depreciable life of the identified assets.
For example, a taxpayer that owns a manufacturing facility could classify the cost of certain equipment foundations, exhaust and ventilation systems, and electrical distribution as tangible personal property. Certain site improvements such as landscaping, underground utilities, and site lighting could qualify as land improvements.
Knowing the difference is critical. So is the ability to support and document the decisions. That is why you need expert advice. Identifying items to be reclassified is only half the battle. The other half is to determine the costs legitimately associated with each item. The complication is locating single-item costs. For example, suppose you know that a portion of your facility’s electrical distribution for specific manufacturing equipment should be in the shorter-life category. You look at the contractor’s charges under electrical and find that all the electrical costs for the job are bundled into a single number, but you need only the cost associated with electrical distribution serving manufacturing equipment.
Our cost segregation specialists can un-bundle the costs and assign them appropriately – not only the direct costs, but also a portion of any indirect costs, such as architect and engineering fees, contractors general conditions, permits, bonds, etc. We have extensive knowledge of construction methods, engineering, and the Internal Revenue Code including the applicable Tax Court cases and Revenue Rulings. Our expertise is the ability to read blue prints and fully understand construction materials, cost, and taxation. We are consultants that bridge the gap between your accountants and the construction team.
Contact Us to learn more.
Toll Free at 1.866.303.6695
or Visit our Website at: http://www.costsegleader.com
2009 IRS 5 Year NOL Carry Back – How Cost Segregation Can Add Benefit
President Obama signed H.R. 3548, The Worker, Homeownership, and Business Assistance Act of 2009 into law. One of the provisions of the act is the extension of a Five Year NOL Carry Back to most businesses for 2008 or 2009. Previously, under the American Recovery and Reinvestment Act of 2009, eligible small businesses (with average gross receipts of $15 Million or less) were allowed to carry back Net Operating Losses (NOLs) from 2008 for three, four or five years rather than the standard two years.
The new act expands the election to allow most businesses (large and small) to carry back NOLs incurred in 2008 or 2009 (typically not both) to the previous five years. Under the new act, an NOL carried back to the fifth year before the loss is limited to 50% of the available taxable income for that year. Any remaining NOL can then be applied in remaining four carry back years.
BENEFIT: A business can carry back an NOL to a previously profitable year and obtain a refund for taxes paid in that year.
CONSIDERATION: Eligible businesses that own commercial or residential rental property should consider having a cost segregation study performed for the 2009 tax year. A properly performed Engineering Based Cost Segregation Study can increase the amount of the NOLs to be carried back and thus will provide a larger refund.
MAXMIZE YOUR TAX REFUND NOW!