1 planning opportunities with cost segregation & related topics during administration presented...
TRANSCRIPT
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Planning Opportunities with Cost Segregation &
Related Topics During Administration
Presented By: Robert S. Keebler, CPA MSTVirchow, Krause and Company, LLP
Phone: (920) 490 – 5634Fax: (920) 499 -1050
E-Mail: [email protected]
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Overview
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§ 1014 Basis of property acquired from a decedent.
• (a) In general. Except as otherwise provided in this section, the basis of property in the hands of a person acquiring the property from a decedent or to whom the property passed from a decedent shall, if not sold, exchanged, or otherwise disposed of before the decedent's death by such person, be—
(1) the fair market value of the property at the date of the decedent's death,
(2) in the case of an election under either section 2032 or section 811(j) of the Internal Revenue Code of 1939 where the decedent died after October 21, 1942, its value at the applicable valuation date prescribed by those sections
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§ 1223 Holding period of property.
• (9) In the case of a person acquiring property from a decedent or to whom property passed from a decedent (within the meaning of section 1014(b) ), if—
(A) the basis of such property in the hands of such person is determined under section 1014 , and (B) such property is sold or otherwise disposed of by such person within 1 year after the decedent's death, then such person shall be considered to have held such property for more that 1 year (i.e. long-term capital gain)
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Example• Tom owns a building with a basis of $50,000. He dies leaving
the interest in the property to his son, Marc. The property at the time of death has a fair market value of $250,000. The basis in the building is stepped-up from $50,000 to $250,000. When Marc eventually sells the property, he will be treated as if he purchased the building for $250,000. A subsequent sale of the property will result in long-term capital gain treatment (IRC §1223 (9)(A)-(B)) .
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Cost Segregation
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Cost Segregation Study A systematic and thorough investigation
of all costs, direct or indirect, associated with the construction or assemblage of an asset or group of assets. The study should result in the proper classification of the assets for tax purposes. The process of the study incorporates accounting, engineering and appraisal techniques and methods.
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Cost Segregation Goals
• Improve cash flow– Many items have a faster recovery period than real
property– Accelerate deductions
• Maximize tax benefit• Proper classification of assets• Document for audit defense• Provide fixed asset detail
– Tax depreciation– Book depreciation– Property tax reporting– Insurance records
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Why Bother?
Many items included in a real estate transaction have a tax life shorter
than 39 years!
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Items with Shorter Recovery Periods
• Site improvements• Specialized electrical systems • Specialized plumbing systems • Telephone computer equipment• Removable floor coverings (carpet, VCT, some tile and
wood)• Cabinetry• Dock bumpers and seals• Special exhaust systems• Decorative lighting• Signage• Emergency generators• Overhead cranes and craneways
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Cost Segregation Example
• Sample property– New office building– $5,000,000 in construction cost– 39% effective tax rate– Discount factor for project evaluation 8%
• Amount to reclassify (estimated)– 15 year property, 8%, $400,000– 7 year property, 1%, $ 50,000– 5 year property, 15%, $750,000
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Tax YearBefore Cost
AnalysisAfter Cost Analysis
Accelerated Deduction
After-Tax Estimated
Benefit
2007 15,400 177,100 161,700 63,1002008 30,800 290,200 259,400 93,7002009 30,800 186,900 156,100 52,2002010 30,800 123,400 92,600 28,7002011 30,800 118,600 87,800 25,2002012 30,800 72,600 41,800 11,1002013 30,800 28,100 (2,700) (700)2014 30,800 25,800 (5,000) (1,100)2015 30,800 23,600 (7,200) (1,500)2016 30,800 23,600 (7,200) (1,400)
Ten Year Effect 292,600 1,069,900 777,300 269,300
All Future Years (47,500)
Present Value Savings Over The Life Of The Project 221,800
Annual Depreciation Schedule
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Manufacturing Building
32%
10%2%
55%
1%
39 YEAR 15 YEAR 7 YEAR 5 YEAR OTHER
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Office Building
55%
8%5%
30%
2%
39 YEAR 15 YEAR 7 YEAR 5 YEAR OTHER
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Retail Operations
45%
2%
37%
15%1%
39 YEAR 15 YEAR 7 YEAR 5 YEAR OTHER
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Example: Factory Conversion
• Existing factory converted to office– Old factory purchased for $2,200,000 in 1995– In 1999, the factory was turned into office space through a
$6,300,000 remodeling project– Most of cost in 39-year property
• Study results, amount reclassified (approximate)– 15 year property, $70,000– 5 year property, $2,700,000
• Benefit to taxpayer– $2,000,000+ current tax year, catch-up depreciation– Net present value of $575,000
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Example: R & D Facility• Existing facility added new offices and lab
– New construction cost of project exceeded $26.5 million– Project was eligible for bonus depreciation and state
credits– Most of cost in 39 year property
• Study results, amount reclassified (approximate)– 15 year property, $1 million– 5 year property, $14.5 million
• Benefit to taxpayer– $4.6 million additional current tax year depreciation– Net present value of $2.3 million
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Example: Residential Property
• Newly constructed senior living facility– Construction cost of $20 million– Current year project, eligible for bonus depreciation– Most of cost in 27 1/2 year property
• Study results, amount reclassified (approximate)– 15 year property, $700,000– 5 year property, $5,000,000– Expense or Amortized costs, $1,300,000
• Benefit to taxpayer– $4.3 million additional current tax year depreciation– Net present value of $1,500,000
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Suitable for those who can use the extra tax depreciation.
Examples where cost segregation studies would not make sense include:
– Taxpayers with operating losses– Tax-exempt entities
Usually, construction cost or the purchase price of a building should exceed $1 million.
Who Can Use A Cost Segregation Study?
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Additional Considerations• Effective tax rate• AMT taxpayer• Passive or active participant
– Grouping elections– Entity planning– Real Estate professional– Other passive income
• Qualified leasehold improvements– 15-Year depreciation through 12/31/2007– Buildings older than three years old– Non-structural improvements to tenant space
• HVAC, general lighting, fire protection, interior partitions– Does not apply to common areas
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Additional Considerations
• Like-kind exchanges– Opportunity if significant new basis added
• Holding period– Sale within 5 years not likely to generate
enough tax benefit
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Additional Considerations• Tenant allowances
– How to depreciate– Who gets personal property– Larger or smaller allowances
• Sales and use tax exemptions– Manufacturers and not-for-profits
• Disposal analysis– Proper valuation of asset classes– Minimize depreciation recapture through recognition
of true physical depreciation– Minimize tax liability upon sale
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Applications Beyond New Construction
• Purchase of existing buildings (Allocation Study)
• Buildings which are acquired through inheritance
• Acquisition of an ownership interest in a partnership or LLC which owns buildings (Allocation Study)
• Building expansions• Tenant improvements
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After Death Depreciation Issues
• Persons acquiring depreciable property from a decedent receive a basis step-up to the fair market value at the date of the decedent’s death (IRC § 1014)– This, in essence, wipes out the previous depreciation
recapture amount– “Resets” the depreciable basis, which means
additional depreciation for the beneficiaries
• The depreciation life of the asset also start all over (see example on next slide)
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One Year Catch-upFor the Period Before Death
• Catch-up on depreciation allowed in Rev. Proc. 2002-9 to be taken on a single tax return
• Likely to generate substantial refunds for 2007 and earlier years
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Example
• Jill purchased an apartment complex for $500,000, which has a 27.5 year depreciable life. Ten years later, Jill passes away. The building had accumulated depreciation of $172,729 and a fair market value of $1,200,000. Jill’s son inherits the property. He will receive the property with a $1,200,000 stepped-up basis and be able to depreciate that over a new 27.5 year life.
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Cost Segregation Study vs.
Allocation Report
• Look similar• Identify property by type• Terms sometimes interchanged• Usually performed as an appraisal• Are not the same
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Cost Segregation Study
• New property, first occupancy• Contractor’s statement• Separately purchased items• Allocable fees
– Professional fees: architect, engineer, testing, legal– Contractor’s overhead and profit, general conditions
• Capitalized interest– Interest incurred during construction period– Allocable, pro-rata– Interest allocated to personal property can possibly be
expensed
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Allocation Report • Used Property (Generally)
– Tie to purchase price– Need to determine appraisal depreciation
Physical Functional Economic
– Could have Goodwill
• Construction costs unknown or irrelevant• Not the first use of the property• Fair market value needs to be established
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Legal Authority
• IRS Audit Techniques Guide• IRS Code• Over 75 cases and rulings to help define what is personal• Removablity and re-use• Function of property
– Does it act as a piece of equipment– Does it exist to support a piece of machinery or
equipment• Court cases and rulings
– Some positive, some negative– Fact and circumstances
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Other Estate Administration Issues
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Income in Respect of a Decedent (IRD)
Income in respect of a decedent (IRD) – is all items of gross income in respect of a decedent which were not properly included as taxable income in a tax period falling on or before a taxpayer’s death and are payable to his/her estate and/or another beneficiary
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Income in Respect of a Decedent (IRD)
Specific Items of IRD
• IRAs and other qualified retirement plans• Unpaid salaries/wages at the time of death• Dividends and interest earned, but not taxed,
prior to death• Unrecognized capital gain on an installment note
at the time of the seller’s death
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IRC §691(c) Deduction
• To the extent that a decedent’s taxable estate includes items of IRD and a federal estate tax is assessed, the estate and/or its beneficiaries are entitled to an income tax deduction for the estate tax attributable to IRD– This deduction is a miscellaneous itemized
deduction NOT subject to the 2% AGI limitation
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Reasons for Giving IRD Assets to Charity
• Take advantage of the benefits provided by cost segregation
• Estate and income tax minimization
• Satisfaction of charitable inclinations
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• At death proceeds of IRAs are subject to:– Income tax to beneficiary– Estate tax
• Thus, beneficiary may incur taxes of over 50% and only receive “net” of 50% of fair market value of IRA
• However, if the IRA is paid directly to charity at death (via beneficiary designation) no income taxes or estate taxes will generally be incurred
Testamentary Bequest – IRA Bequest
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Testamentary Bequest – IRA BequestExample
Taxpayer currently has a taxable estate comprised of the following assets:
FMVAdjusted Cost
BasisCash & Money Market Accounts 50,000$ 50,000$ Marketable Securities (non-qualified) 5,900,000 850,000 IRA 750,000 - Rental Real Estate 750,000 275,000 Other Assets 50,000 75,000 Taxable Estate 7,500,000$ 1,250,000$
At the present time, Taxpayer is determining whether he wants to fulfill his testamentary charitable bequest by leaving either his IRA or his rental real estate to a public charity. In this case, Taxpayer wants to leave the asset that will have the least tax consequence to his estate (or its beneficiaries). Assuming that Taxpayer dies in 2008, the following compares the tax liabilities that would be incurred leaving an IRD asset (i.e. IRA) or a non-IRD depreciable asset (i.e. rental real estate) to charity at death.
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Testamentary Bequest – IRA BequestExample (cont.)
Rental Real Estate
Bequest IRA BequestIRD Assets (i.e. IRA) 750,000$ 750,000$ Non-IRD Assets 6,750,000 6,750,000 Gross Estate 7,500,000$ 7,500,000$ Less: Charitable Bequest (500,000) (500,000) Less: Exemption (2,000,000) (2,000,000) Taxable Estate 5,000,000$ 5,000,000$
Estate Tax Liability @ 45% 2,250,000$ 2,250,000$
IRD Assets 750,000$ 750,000$ Less: Charitable Bequest - (750,000) Less: Deduction for Estate Tax (337,500) - Taxable Portion of IRD 412,500$ -$
Built-In Income Tax Liability on IRD @ 35% 144,375$ -$
Depreciable Assets (i.e. Rental Real Estate) 750,000$ 750,000$ Less: Charitable Bequest (750,000) - Net Assets Available for Depreciation -$ 750,000$
Future Income Tax Savings on Depreciation @ 35% -$ 262,500$
RECAPEstate Tax Liability 2,250,000$ 2,250,000$ Built-In Income Tax Liability on IRD 144,375 - Less: Future Income Tax Savings on Depreciation - (262,500) Total Tax Liability 2,394,375$ 1,987,500$
SAVINGS 406,875$
