Cost Segregation Studies: Best Practices Reclassifying Business Personal Property to Achieve Income and Property Tax Benefits

Transcription

1 Presenting a live 110 minute teleconference with interactive Q&A Cost Segregation Studies: Best Practices Reclassifying Business Personal Property to Achieve Income and Property Tax Benefits THURSDAY, APRIL 5, pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: Daniel McGrath, Director, Grant Thornton,, Chicago Gian Pazzia, Principal, KBKG Inc., Pasadena, Calif. Julio Gonzalez, Founder and CEO, Engineered Tax Services, West Palm Beach, Fla. Dennis Duffy, President, Duffy + Duffy Cost Segregation Services Inc., Westlake, Ohio For this program, attendees must listen to the audio over the telephone. Please refer to the instructions ed to the registrant for the dial-in information. Attendees can still view the presentation slides online. If you have any questions, please contact Customer Service at ext. 10.

2 Conference Materials If you have not printed the conference materials for this program, please complete the following steps: Click on the + sign next to Conference Materials in the middle of the left- hand column on your screen. Click on the tab labeled Handouts that appears, and there you will see a PDF of the slides for today's program. Double click on the PDF and a separate page will open. Print the slides by clicking on the printer icon.

3 Continuing Education Credits FOR LIVE EVENT ONLY Attendees must listen to the audio over the telephone. Attendees can still view the presentation slides online but there is no online audio for this program. Attendees must stay on the line for at least 100 minutes in order to qualify for a full 2 credits of CPE. Attendance is monitored as required by NASBA. Please refer to the instructions ed to the registrant for additional information. If you have any questions, please contact Customer Service at ext. 10.

4 Tips for Optimal Quality Sound Quality For this program, you must listen via the telephone by dialing and entering your PIN when prompted. There will be no sound over the web connection. o If you dialed in and have any difficulties during the call, press *0 for assistance. You may also send us a chat or sound@straffordpub.com immediately so we can address the problem. Viewing Quality To maximize your screen, press the F11 key on your keyboard. To exit full screen, press the F11 key again.

5 Cost Segregation Studies: Best Practices Seminar April 5, 2012 Dennis Duffy, Duffy + Duffy Cost Segregation Services Inc. dduffy@costsegexperts.com Daniel McGrath, Grant Thornton daniel.mcgrath@us.gt.com Gian Pazzia, KBKG Inc. gian@kbkg.com Julio Gonzalez, Engineered Tax Services jgonzalez@engineeredtaxservices.com

6 Today s Program Reasons To Perform A Cost Segregation Study Slide 7 Slide 12 [Dennis Duffy] When To Start The Process With A New Facility [Daniel McGrath] Slide 13 Slide 16 Performing A Retroactive Study [Daniel McGrath] Slide 17 Slide 21 Applicable Rules, Standards And Guidance [Gian Pazzia] Slide 22 Slide 41 Designing A Study With Defending It In Mind [Julio Gonzalez and Dennis Duffy] Slide 42 Slide 46 Experiences With Audits [Dennis Duffy, Daniel McGrath, Gian Pazzia, Julio Gonzalez] Slide 47 Slide 50

7 Dennis Duffy, Duffy + Duffy Cost Segregation Services Inc. REASONS TO PERFORM A COST SEGREGATION STUDY

8 Standard Features Of The Cost Segregation Process Gather basic information about the property and the owner s tax situation Prepare a projection of the accelerated depreciation and an estimate of the net present value of the deferrals Evaluate estimate cost and other tax ramifications, and discuss with owner If a study is desirable, gather construction drawings, specifications and cost data Perform site visit to verify drawings, take photos and gather further information Prepare and deliver report 8

9 Reasons To Perform A Cost Segregation Study Cost segregation studies can provide property owners with accelerated depreciation deductions that defer income tax. Many property owners are unaware of the benefits of cost segregation. Many owners do not know that studies can be applied retroactively to properties acquired in the past. The accelerated depreciation deductions generated do not require an additional cash outlay. 9

10 Identifying Construction Related Costs That Can Be Depreciated Over A Shorter Life Separates non-structual elements, exterior land improvements and indirect conctruction costs Tangible personal property (Sect property) Not structural components of a building Does the item relate to the operation or maintenance of the building? Land improvements Can be Sect or Sect property Does not include costs inextricable to the land Indirect construction costs Soft costs such as permits, architect fees, builders overhead and profit Indirect costs can be allocated to the asset to which they relate. 10

11 Adjusting Timing Of Depreciation To Maximize Cash Flow For Other Purposes For new construction: Significantly higher deductions in the early years, amplified by bonus depreciation and a higher Sect. 179 limit For existing properties: Immediate recapture of retroactive deductions on property acquired since 1987 Catch-up Sect. 481A adjustments, taken in year of change witout amending! In certain circumstances, this may produce a net operating loss that can be carried back to produce refunds of tax paid in previous years. 11

12 Reducing Property Tax Studies can be used for property tax appeals. A study conducted before property acqusition may be used to specify personal property tax. Personal property enumerated in purchase agreement May reduce transfer tax on real estate 12

13 Daniel McGrath, Grant Thornton WHEN TO START THE PROCESS WITH A NEW FACILITY

14 Current Year Study Process When to begin New construction/expansion/remodel Pre-construction ti Formal process Informal process During construction Formal process Informal process Post-construction Acquired facility 14

15 Current Year Study Process (Cont.) Whom to involve Internal personnel VP of tax/director of tax/tax manager Head of construction or real estate/project engineer/facility manager Fixed asset manager IT representative External expertise Cost segregation provider Tax compliance provider Contractor personnel Project architect/engineer 15

16 Current Year Study Process (Cont.) Co-sourcing opportunities Scope of work Pros Cons New construction Acquisition Potentially reduced professional fees Increased tax department involement in fixed asset decisions and operations Work for under-utilized personnel Personnel time demands Fee reductions less significant than anticipated 16

17 Daniel McGrath, Grant Thornton PERFORMING A RETROACTIVE STUDY

18 Retroactive Studies Ability to apply cost segregation to prior-year assets Typically yields more significant benefits than a current-year study Porfolio of properties Small projects for which current year cost seg didn t make sense Prototype facilities utilizing statistical sampling Assets placed in service since 1/1/87 Current-year Sect. 481(a) catch-up adjustment Bonus depreciation and qualified leasehold improvement property Form 3115 automatic change in accounting method Can complete study up until extended due date of return Additional opportunities related to expensing repairs 18

19 Retroactive Studies (Cont.) Types of assets to include Constructed/expanded/remodeled buildings Acquired buildings (asset or stock deals) Build-out of leased space Project indirect costs One-off asset additions Whom to involve 19 Replace carpeting Add computer room A/C Network cabling Parking lot expansion New production line

20 Process Retroactive Studies (Cont.) Review tax depreciation schedule Data request Facility site visits and interviews Cost analysis Estimate costs from blueprints and construction cost data manuals Recalculate depreciation and calculate Sect. 481(a) adjustment Prepare Form 3115 Create deliverable, including workpaper documentation Upload results into fixed asset system Update capital asset manual and/or process for the future 20

21 Retroactive Studies (Cont.) Co-sourcing (more opportunities and efficiencies than current-year studies) Potential company personnel scope of work Pros Cons Populate templates and analyze costs Gather quantities of assets to reclassify Calculate depreciation and 481(a) adjustment Assemble supporting documentation Potentially reduced professional fees Increased tax department involvement in fixed-asset decisions and operations Work for under-utilized personnel Personnel time demands Fee reductions less significant than anticipated 21

22 Gian Pazzia, KBKG Inc. APPLICABLE RULES, STANDARDS AND GUIDANCE

23 Updates: Economic Stimulus Tax Relief, Unemployment Insurance Reauthorization, ti and Job Creation Act (P.L ) 100% bonus depreciation Property placed in service between 9/9/10 and 12/31/11 Extension of 50% bonus through 2012 (2013 for certain property) NATIONWIDE SERVICE 23 KBKG.com

24 Updates: Economic Stimulus (Cont.) Qualified property is: Qualified leasehold improvements (QLIs) MACRS property with GDS recovery period of 20 years or less Water utility property Computer software (with the exception of software covered by Sect. 197 (purchased as part of a business) Long production period property Qualified property is not: Qualified restaurant and retail improvements Alternative depreciation system (ADS) NATIONWIDE SERVICE 24 KBKG.com

25 Rev. Proc Component election Special election available in 2010 AND 2011 to componentize construction costs Anything incurred after Sept. 8, 2010 gets 100% bonus Even if more >10% project complete and paid for before 9/8/2010 Without this election, you are limited to 50%. NATIONWIDE SERVICE 25 KBKG.com

26 Rev. Proc (Cont.) Component election (Cont.) Example: Client starts construction on $10M building in June Complete $2M by Sept 8, 2010 ($500k is bonus eligible) $8M completed after 9/8/2010 ($2M is bonus eligible) Everything is placed in service in Without election: ALL short life property gets 50% bonus = $1.25M. With election: Any short life property segregated from $8M gets 100% bonus = $2.25M. Difference of $1M of deductions in Year 1 NATIONWIDE SERVICE 26 KBKG.com

27 Rev. Proc (Cont.) Qualified restaurant and retail property, and bonus eligibility Bonus regs say qualified retail/restaurant property p is not bonus- eligible. Bonus eligible : If property is both qualified restaurant/retail property AND qualified leasehold improvement NATIONWIDE SERVICE 27 KBKG.com

28 Rev. Proc , 26 QLI And LPPP Long production period property Clarification that long production period property started in 2011 can still get 100% bonus deprecation on the entire basis, as long as it s placed in service in 2012 LPPP defined: Tax life over 10 years, costs exceeding $1M, and production period over 1 year NATIONWIDE SERVICE 28 KBKG.com

29 Rev. Proc , QLI And LPPP (Cont.) Long production period property (Cont.) Example: Client is spending $3M on tenant improvements. Meets criteria for qualified leasehold improvement property (15- year life) Started in February 2011 and will be done in April 2012 (> 1 year) ALSO meets criteria for LPPP Entire amount gets 100% bonus treatment, because it took longer than 1 year! If completed in January 2012, it would all get 50% bonus. Difference of $1.5M of deductions in Year 1! NATIONWIDE SERVICE 29 KBKG.com

30 15-Year Improvement Depreciation Quick Reference NATIONWIDE SERVICE 30 KBKG.com

31 Recent Developments/Case Law PPL Corporation v. Commissioner (July 28, 2010) Electric utility s street lighting - depreciable over 7 years IRS Guidance (CCA ) 2011 Truck service stations: Asset class 57.1, with 15-year tax life Rev. Proc : Rules for Statistical Sampling Estimates IRS criteria to determining whether to accept a statistical sampling Temp regs for 263(a): Repair vs. capitalization, Dec. 23, 2011 Peco Foods vs. Commissioner (January 2012) Amerisouth TC Memo (March 2012) Rev. Procs and NATIONWIDE SERVICE 31 KBKG.com

32 Temp Regs For 263(a): Repair V. Capitalization ti Guidance when certain building expenditures should be expensed Significant changes to the 2008 proposed regs Clarification of unit of property definitions Define nine building systems and require each to be treated as its own UOP, for repair vs. capitalization analysis Major structural component includes any combination of parts that perform a discrete and critical function Define improvement as betterment, restoration or adaption Plan of rehabilitation doctrine is now obsolete! Removal of structural component is a disposition; can now write off the remaining basis of 1250 building items removed NATIONWIDE SERVICE 32 KBKG.com

33 Temp Regs For 263(a): Repair V. Capitalization ti (Cont.) Example: Client constructed t 3-storey office building in 2002 for $5M. In 2008, business spent spend $1M to remodel portion of 2 nd floor (ceilings, walls, lighting, plumbing, ducting, electrical wiring, etc.). Did cost seg on $1M remodel But, also realized greater benefits from retirement of items demolished/abandoned Abandonment study on original building: Engineer identified and quantified an additional $400K of deductions in Year 1. NATIONWIDE SERVICE 33 KBKG.com

34 Temp Regs For 263(a): Repair V. Capitalization ti (Cont.) Plan of rehabilitation ti doctrine is now obsolete. Client spends $3M on a remodel. Costs include work on portion of roof, asphalt patching/resurfacing, 2 HVAC unit replacements, painting. Old rules All capitalized New rules require a UOP analysis to determine if those can be expensed in the current year. Make sure you are using a cost segregation firm that fully understands all the new rules under repair regulations. NATIONWIDE SERVICE 34 KBKG.com

35 RP And RP Both Modify Rev. Proc (Change of Accounting Methods) IRS Procedure Deducting repair and maintenance costs Capitalizing acquisition or production costs Capitalizing improvements to tangible property IRS Procedure Dispositions o s of MACRS property Depreciation of leasehold improvements (can t amortize over life of lease) Changes in tax life for property depreciated under MACRS Simplified process by allowing two or more concurrent changes of accounting to be filed on single Form Allow the use of statistical sampling for certain changes, as long as the sampling plan follows guidelines in Rev. Proc NATIONWIDE SERVICE 35 KBKG.com

36 Peco Foods, Inc., TC Memo , January 2012 Acquired two poultry processing plant businesses Purchase agreement included a schedule allocating purchase price among assets, which included building improvements and machinery and equipment. This is a Sect transaction (sale of a trade or business), so the company filed the required ed Form Peco did a cost segregation study following the purchase and was denied under audit. Tax Court ruled in favor of the IRS. NATIONWIDE SERVICE 36 KBKG.com

37 Peco Foods, Inc., TC Memo (Cont.) Is this applicable to all real estate transactions? The courts examined how the purchase agreement defined building improvements and personal property. Those definitions did not consider the IRC definitions. Be very careful about how the purchase agreement is worded! Consult with a cost segregation expert that understands this case. Do not use the term building to describe the facility. Be specific and provide a schedule of the FF&E and M&E. Make sure to define personal property and reference back to that list. Consider doing a cost segregation before the purchase, so that the buyer and seller agree to allocations. NATIONWIDE SERVICE 37 KBKG.com

38 AmeriSouth XXXII, Tax Court Memo (March 2012) Acquired an apartment complex in 2003 for $10.25 million Hired a cost segregation firm to do the study AmeriSouth sold property at about the time the case was tried, and stopped responding to communications from the court. The case could have been dismissed entirely. But, since AmeriSouth didn t file a post-trial brief, the court deemed any factual matters not otherwise contested to be conceded. Tax Court denied almost all the items reclassified in the cost segregation study. NATIONWIDE SERVICE 38 KBKG.com

39 AmeriSouth XXXII, Tax Court Memo (Cont.) This has been brewing for a few years. KBKG believes some positions taken in the cost segregation study were aggressive, but most were not. Site utilities are generally not 15-year property. Kitchen sinks, plumbing and cabinetry, and finish carpentry Stove hoods, electrical panels KBKG knows of two more cases going g to Tax Court on these issues and believes the results will be different. NATIONWIDE SERVICE 39 KBKG.com

40 179D For Commercial Buildings Immediate deduction of up to $1.80/square foot for commercial buildings that are 50% more energy efficient than under certain 2001 building standards Not related to Sect. 179 expensing Partially qualifying property Whole $1.80/square foot Up to $0.60/square foot for building envelope Up to $0.60/square foot for HVAC Up to $0.60/square foot for interior lighting NATIONWIDE SERVICE 40 KBKG.com

41 American Society Of Cost Segregation Professionals ASCSP Required testing and experience requirements to be certified (CCSP) Requires reports adhere to ASCSP standards and Code of Ethics Ongoing training, education and certification procedures for cost segregation consultants IRS engineers guest speaker at several ASCSP Conferences ASCSP issues comments to IRS on repair regulations. ASCSP position on AmeriSouth case. ASCSP commentary on Peco Foods case NATIONWIDE SERVICE 41 KBKG.com

42 Julio Gonzalez, Engineered Tax Services Dennis Duffy, Duffy + Duffy Cost Segregation Services Inc. DESIGNING A STUDY WITH DEFENDING IT IN MIND

43 Best Practices For A Defensible Audit Trail Principal Elements Of A Defensible Cost Segregation Study The 13 principal elements of a defensible study are: 1) Preparation by an individual with expertise And experience 2) Detailed description of the methodology 3) Use of appropriate documentation 4) Interviews conducted with appropriate parties 5) Use of a common nomenclature 6) Use of a standard numbering system 7) Explanation of the legal analysis 8) Determination of unit costs and engineering take-offs 9) Organization of assets into lists or groups 10) Reconciliation of total allocated costs to total actual costs 11) Explanation of the treatment of indirect costs 12) Identification and listing Of Sect property 13) Consideration of related aspects (e.g., IRC 263A, change in accounting method and sampling techniques) 43

44 Best Practices For A Defensible Audit Trail (Cont.) A cost segregation report reflects a study s methodology and conclusions. The amount of detail included in a report can vary considerably, depending di upon the service provider. However, the subsequent fundamentals are consistently it tl found in a defensible report. 1) Summary letter/executive summary A defensible report contains a summary to identify: The preparer; the date of the study; the taxpayer (or client); the subject property; and the property components classified as land, land improvements, building or personal property. 2) Narrative report A defensible report discusses the theory, definitions and rationale behind the study in the narrative section. This section generally includes a more detailed description of the property/facility (i.e., a physical description and an explanation of the use for which it is intended, as well as a legal description of the property and its location). In addition, the narrative section highlights the regulations, rulings and court cases that support classifying assets as 1245 property. The narrative also discusses the types and sources of data used (e.g., cost records, contracts, purchase agreements, published estimates) as well as how they were used. 3) Schedule of assets A quality report has a schedule of assets that t are the focus of the study. Generally, this schedule ties directly to the taxpayer s depreciation records. When a taxpayer reallocates costs of assets already on the books, a quality report clearly identifies the specific assets affected (and includes depreciation records from both before and after the reallocation). 4) Schedule of direct and indirect costs A quality report lists all direct and indirect costs associated with a project. Indirect costs allocated to 1245 property are clearly identified and explained. Separately-acquired assets are listed and discussed in the report. to avoid duplication errors. Costs subject to IRC 263A also are addressed. 44

45 Best Practices For A Defensible Audit Trail (Cont.) 5)) Schedule of p property p y units and costs A defensible report provides a schedule of property units and costs (with property descriptions) that are segregated into land, 1245 property and 1250 property. This schedule is the final product of the study and serves as the basis for computing depreciation. 6) Engineering procedures A defensible report describes the engineering procedures and methodology for determining the cost of each property unit. It also identifies the specific taxpayer records that were reviewed, and discusses whether actual cost records or estimating techniques were utilized to break costs into smaller components. A record of inspections and/or interviews is included as well. The use of a common nomenclature or a standard numbering system also is referenced and/or explained. 7) Statement of assumptions and limiting conditions A defensible report describes the general understanding and conditions applicable to the report. This information may also provide an indication of the overall quality of the study. 8) Certification A defensible report certifies that the person who signed the report actually developed the analysis, opinions and conclusions of the report. This section may also include the resume or state the credentials and/or level of experience of the preparer. 9) Exhibits A defensible report generally includes various exhibits, such as the Client cost sources and the Cost S Source R Reconciliation. ili ti These Th exhibits hibit show h th the b book k (GAAP fi financial i l accounting) ti ) records d on which hi h th the preparer relied in deriving total costs, and may include a reconciliation of the study to the fixed asset ledger. Photographs and/or videos may also be included as exhibits, to assist in understanding the assets in the study. 45

46 Creating An Audit Trail, From Construction Drawings Through Reports Drawings are maintained as part of the study documentation. Use of take-off sheets to record measurements and counts Adequate photographs and descriptions Reference to case law and/or IRS guidance for items segregated 46

47 Dennis Duffy, Duffy + Duffy Cost Segregation Services Inc. Daniel McGrath, Grant Thornton Gian Pazzia, KBKG Inc. Julio Gonzalez, Engineered Tax Services EXPERIENCES WITH AUDITS

48 IRS Audit Experiences IRS wants a clear audit trail and rarely challanges take-offs or costs. Agents rely on the IRS Audit Techniques Guide for authorative support. Guide clearly states that it is not intended as an official IRS pronouncement and may not be cited as authority. Case law is factually intensive, and rulings often conflict. 48

49 IRS Audit Experiences (Cont.) Historical (pre-2010) Frequency Experience of IRS personnel Examples Typical situations Restaurant franchisee Medical office building Current and prospective 49 Frequency Primary focus has been repairs-expensing expensing Depreciation

50 Case Study: Lighting Retrofit 200,000-sq-ft. industrial building In 2011, spent $300,000 to replace all the lighting KBKG s analysis $250, Lighting Meets 50% test All the lighting meets the test Deduction = $120,000 (200,000 x $0.60) Client expenses $120,000 in the current year. Instead of depreciating the whole $300k over 39 years 200,000 SF Shopping Center Expense $120,000 in current year Deduction = $120,000 (200,000 x $0.60) NATIONWIDE SERVICE 50 KBKG.com