Cost Segregation Opportunities J.D. Lewis Principal November 10, 2015 Elliott Davis Decosimo, LLC Elliott Davis Decosimo, PLLC
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What is Cost Segregation? 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) Elliott Davis Decosimo, LLC Elliott Davis Decosimo, PLLC
Types of Cost Segregation Projects 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 Elliott Davis Decosimo, LLC Elliott Davis Decosimo, PLLC
Section 1250 Real Property 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) Elliott Davis Decosimo, LLC Elliott Davis Decosimo, PLLC
Section 1245 Personal 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 Elliott Davis Decosimo, LLC Elliott Davis Decosimo, PLLC
Concerns Around Cost Segregation 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) Elliott Davis Decosimo, LLC Elliott Davis Decosimo, PLLC
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 2014 Elliott Davis, PLLC 2014 Elliott Davis, LLC
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 2014 Elliott Davis, PLLC 2014 Elliott Davis, LLC
Case Studies Client A New Apartment Complex Client B Depreciable basis: $22,310,062 Year 1 Increased Depreciation: $3,337,737 New Manufacturing Facility Client C Depreciable basis: $38,961,271 Year 1 Increased Depreciation: $7,222,644 Remodel of Existing Car Dealership Depreciable basis: $927,611 Year 1 Increased Depreciation: $154,958 Client D Orthodontics Office Construction Depreciable basis: $1,354,745 Year 1 Increased Depreciation: $302,099 Client E Dental Office Build-Out Depreciable basis: $900,000 Year 1 Increased Depreciation: $147,100 Client F New Bank Branch Construction Depreciable basis: $2,135,336 Year 1 Increased Depreciation: $474,013 Elliott Davis Decosimo, LLC Elliott Davis Decosimo, PLLC
Final Tangible Asset Regulations 2014 Elliott Davis, PLLC 2014 Elliott Davis, LLC
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 2014 Elliott Davis, PLLC 2014 Elliott Davis, LLC 12
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 Profitable or expecting to turn profit in near future. 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
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: jdlewis@elliottdavis.com 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. Elliott Davis Decosimo, LLC Elliott Davis Decosimo, PLLC