cost segregation opportunities - elliott davis · presentation is for informational purposes and...

Cost Segregation Opportunities

© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC

J.D. Lewis Principal November 10, 2015

This material was used by Elliott Davis Decosimo during an oral presentation; it is not a complete record of the discussion. This presentation is for informational purposes and does not contain or convey specific advice. It should not be used or relied upon in regard to any particular situation or circumstances without first consulting the appropriate advisor. No part of the presentation may be circulated, quoted, or reproduced for distribution without prior written approval from Elliott Davis Decosimo.


•A detailed analysis of all of the hard and soft cost associated with construction of an asset into appropriate depreciable life; typically 39 year to a shorter life

•Applies to new construction, leasehold improvements or purchase of existing properties in current AND prior tax years

•NPV for every $1M reclassified from 39 year property to a shorter life could exceed 200k (assuming 50 percent bonus applies)


What is Cost Segregation?

• Current – Newly constructed facilities or recently acquired properties – Owned or leased (lease term does not matter – tax real property life

is still 15 or 39 years) – Multiple similar locations – sampling

• Retro (placed in service in prior years)

– Can file a Form 3115 to catch-up missed depreciation in current tax year

• Renovations and Expansions

Types of Cost Segregation Projects


• Basically anything that is permanent in nature or necessary for the operation of the building

– Concrete walls and floors – Structural steel – HVAC for general building operation – Plumbing for HVAC and restrooms – General building electrical (Non-dedicated to personal

property) – Base building lighting and security lighting – Doors & hardware – Drywall – Paint (Takes life of object being painted)

Section 1250 Real Property


• Tangible Personal Property – Must not be land or a land improvement – May be personal even though required by state or local

law or code – All items in the nature of machinery – Must not be a structural component

• Examples: Electrical Conduit and Wiring to Process Equipment, Process Piping, Special Equipment Foundations, Decorative Accent Lighting

Section 1245 Personal Property


• Effect to financial statements? – None – The increased deduction is tax only.

• IRS contention?

– Cost segregation widely accepted by IRS (Cost Segregation, ATG and field directives)

Concerns Around Cost Segregation


Triggers for Cost Segregation

Profitable or expecting to turn profit in near future

• Newly constructed facility • Expansion of a facility • Newly purchased facility • Large $ amount in CIP • Many locations • Significant amounts of long

life property (15+ year tax life) placed in service in prior years

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Benefits of Cost Segregation

•Accelerates tax deductions

• Increases cash flow in a time that credit is tight

•Allows for more accurate bookkeeping of tax fixed assets

•Ability to easily utilize partial disposition election moving forward


Client A • New Apartment Complex

• Depreciable basis: $22,310,062 • Year 1 Increased Depreciation:

$3,337,737

Client B • New Manufacturing Facility


$7,222,644

Client C • Remodel of Existing Car Dealership

• Depreciable basis: $927,611 • Year 1 Increased Depreciation:

$154,958

Client D • Orthodontics Office Construction


$302,099

Client E • Dental Office Build-Out

• Depreciable basis: $900,000 • Year 1 Increased Depreciation:

$147,100

Client F • New Bank Branch Construction


$474,013


Case Studies

Final Tangible Asset Regulations


Background

• September 13, 2013 - Department of the Treasury and the IRS issued final tangible property regulations that provide guidance on the tax treatment of amounts paid to improve, acquire and produce tangible property

• Required to be applied for taxable years beginning on or after January 1, 2014

• Applies to amounts paid to acquire, produce, or improve tangible property

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Practical Implications

Do the new rules apply to my business?

• Rules affect any business that owns or leases tangible property.

Therefore these rules affect all businesses

Improvements to Property

A taxpayer (TP) must generally capitalize an amount that IMPROVES a unit of property ("UOP") if the amount:

1. Is for a betterment;

2. Restores the UOP; or

3. Adapts the UOP to a new or different use

Building Systems

Building systems include: - HVAC systems - Fire protection and alarm systems - Plumbing systems - Security systems - Electrical systems - Gas distribution systems - All escalators - Any other structural components - All elevators in published guidance

Betterments

• General rule: A TP must capitalize an amount paid for a "betterment"

• An amount is paid for a betterment if it: - Ameliorates a material condition or defect that either existed

prior to the TP's acquisition of the property or arose during production of the UOP (regardless of whether the TP was aware of the condition);

- Results in a material addition to or addition of a major component of the UOP, or a material increase in the capacity of the UOP;

- Results in a material increase in productivity, strength, efficiency, or quality of the UOP or the output of the UOP

Restorations

An amount restores property if the amount: 1. Results in the rebuilding of the UOP to a like-new condition after

the end of its class life; 2. Is for the replacement of a part or a combination of parts that

comprise a major component or a substantial structural part of the UOP;

3. Returns the UOP to its ordinarily efficient operating condition if the property has deteriorated to a state of disrepair and is no longer functional for its intended use

Restorations (cont.)

An amount restores property if the amount (cont.): 4. Is for the replacement of a component of a UOP and the TP has

properly deducted a loss for that component (other than a casualty loss);

5. Is for the replacement of a component of a UOP and the TP has properly taken into account the adjusted basis of the component in realizing gain or loss resulting from the sale or exchange of the component; or

6. Is for the repair of damage to a UOP for which the TP has taken a basis adjustment as a result of a casualty loss

Restoration Examples

Restoration

•Entire sprinkler system

•All wiring in building

•All restroom fixtures

•200 of 300 windows

•100 of 300 windows (windows cover 90% of building)

•40% of sq ft of flooring

Not a Restoration

•3 of 10 roof HVAC units

•30% of electrical wiring

•8 of 20 sinks

•100 of 300 windows (300 windows cover 25% of building surface area)

•10% of sq ft of flooring

•1 of 4 elevators

New Annual Elections

• Partial dispositions • De Minimis safe harbor (statement required) • Capitalize repair and maintenance costs (statement required) • Safe harbor for small taxpayers (statement required) • Capitalize and depreciate any rotable, temporary, or

emergency spare part

Partial Dispositions

• Retirement of a structural component no longer mandatory

– Need for general asset account election eliminated

• TP may elect to dispose of a portion of an asset Includes:

– Structural components (or components thereof) of a building

– Components or portions of 1245 assets

• Election is made in year of partial disposal by claiming gain, loss or other deduction on the return

De Minimis Safe Harbor

• TP with an applicable financial statement

• Written accounting procedure in place at beginning of year

• Policy to expense property costing less than a certain dollar amount or property with an economic useful life of 12 months or less

• Deducts such amounts in applicable financial statements

• Amount paid does not exceed $5,000 per invoice (or per item as substantiated by invoice)

De Minimis Safe Harbor (cont.)

TP without an applicable financial statement

• Accounting procedure in place at beginning of year

• Policy to expense property costing less than a certain dollar amount or property with an economic useful life of 12 months or less

• Deducts such amounts in applicable financial statements

• Amount paid does not exceed $500 per invoice (or per item as substantiated by invoice)

Materials and Supplies

Materials and supplies include: • Components acquired to maintain, repair, or improve a unit of

tangible property owned, leased, or serviced by the taxpayer that is not acquired as part of any single unit of property

• Fuel, lubricants, water and similar items expected to be consumed in 12 months or less

• Property with economic useful life of 12 months or less • Property with acquisition cost

Materials and Supplies (cont.)

• Non-incidental supplies - Deductible in the year in which the materials are first used

or consumed in the taxpayer's operations • Incidental supplies

- Deductible in the year in which amounts are paid - Incidental supplies are those for which no record of

consumption is kept or physical inventories at beginning and end of year are not taken

Materials and Supplies – What’s the Effect?

• Final regulations only apply to amounts incurred on or after 1/1/14, unless taxpayer early adopted.

• No retroactive adjustment • Clear definition of materials and supplies • Can elect to deduct under de minimis, applies to all

eligible materials and supplies

Routine Maintenance Safe Harbor

• Amount paid for routine maintenance deemed not to improve property if a taxpayer reasonably expects to perform more than once during:

- 10 year period from PIS date for building property, or - The ADS class life for all property other than building

property • Applied to building structure and each building system, or

UOP for non-building property • Routine activities include: inspecting, cleaning, testing, and

replacement of damaged parts

Elections to Capitalize Repairs & Maintenance Costs

• TP's may elect to capitalize amounts incurred during the year as costs of improvements if TP capitalizes the amounts on its books and records

• Election applies to all amounts treated as capital for books each year

• Election made by attaching a statement to the return each year

Next Steps

• Compare current policies - Acquisition policy (de minimis) - Capitalization policy (repairs)

• Consider modification to current procurement process - Capital expenditures request (CER) - Capital appropriations request (CAR)

• Consider current method change opportunities • Consider annual elections going forward

Potential Method Change Opportunities

• Deduct repair and maintenance costs - Would not make the election to follow book and

capitalize costs • Late partial disposition election to recoup costs from

prior dispositions • Depreciation methods and lives • Materials and supplies • Revocation of general asset account

How Could Repairs Amounts Be Capitalized

• GAAP “Unit of Accounting” capitalization rules differ from tax rules

• Capitalizing items reflect better earnings than expensing

• Failure to understand non-betterments opportunities

Key Repairs Indicators

• Capitalized assets other than acquisitions greater than $1M for any year.

• Capitalized Roofs • Capitalized Parking Lots • Capitalized Concrete

Work • Building Renovations

and Improvements outside the year of acquisition

Profitable or expecting to turn profit in near future.

How Can Elliott Davis Help?

Two Types of Repairs Projects • Phase I - Matrix based approach designed to help clients

maximize repair regulation benefits going forward

• Phase II - Comprehensive fixed asset analysis typically involves a repairs, depreciation, and partial disposition method change in order to catch up on missed deductions in prior years.

Questions & Answers

J.D. Lewis Email: [email protected] Phone: 864.242.2624 Website: www.elliottdavis.com

Elliott Davis Decosimo ranks among the top 30 CPA firms in the U.S. With sixteen offices across seven states, the firm provides clients across a wide range of industries with smart, customized solutions. Elliott Davis Decosimo is an independent firm associated with Moore Stephens International Limited, one of the world's largest CPA firm associations with resources in every major market around the globe. For more information, please visit elliottdavis.com.


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