Now is the Time to Tune-Up your Clients’ Depreciation Schedules

Michael Donohue
December 13, 2012 — 1,390 views  
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Whether or not your clients have already commissioned a Cost Segregation Study, or taken advantage of the 179D Federal Energy Tax Deduction, now is the time to schedule a full-blown ”Tune-Up” of their depreciation schedule.

The IRS opened a window in 2012 that gives commercial property owners a chance to increase depreciation expense and cash flow while reducing taxes. This is possible through “Ghost” Asset Retirement Studies and the “179D” tax deductions available through energy retro-fits authorized in the Energy Policy Act of 2005. You can also write-off the “ghost” assets created when those new “179D” assets were installed. This window is scheduled to close at the end of 2013.

All commercial real estate owners will fit into one of the four following groups.

If they have not had a Cost Segregation Study done, and have not taken advantage of the “179D” tax deductions, you should recommend:

  1. A cost-benefit analysis of having cost segregation applied to their property.
  2. An analysis of the dollar benefit associated with the removal of “Ghost” assets from their depreciation schedule.
  3. If an energy saving retro-fit has been accomplished, have an independent, third-party engineering firm certify the results needed to qualify for “179D” tax deductions. This certification should also insure that none of the items replaced in the retro-fit became “Ghost” assets

If they have had a Cost Segregation Study done, but have not taken advantage of the “179D” tax deductions, you should recommend:

  1. A review of their existing Cost Segregation Study in light of a 2011 Tax Court decision that disqualified a study that did not meet IRS criteria. More importantly, the court concluded that even after the statute is closed on the year that the study was done, if that faulty study is used to calculate depreciation at any time during their ownership of the property, they are vulnerable.
  2. A cost-benefit analysis of the re-application of cost segregation to their property, if indicated.
  3. An estimate of the dollar benefit associated with the removal of “Ghost” assets from their depreciation schedule.
  4. If an energy saving retro-fit has been accomplished, have an independent, third-party engineering firm certify the results needed to qualify for “179D” tax deductions. This certification should also insure that none of the items replaced in the retro-fit became “Ghost” assets

If they have not had a Cost Segregation Study done, and have taken advantage of the “179D” tax deductions, you should recommend:

  1. A cost-benefit analysis of having cost segregation applied to their property.
  2. An analysis of the estimated dollar benefit associated with the removal of “Ghost” assets from their depreciation schedule.
  3. An analysis of the estimated write-offs available from the assets replaced by the “179D” assets.

If they have had a Cost Segregation Study done, and have taken advantage of the “179D” tax deductions, you should recommend:

  1. A review of their existing Cost Segregation Study in light of a 2011 Tax Court decision that disqualified a study that did not meet IRS criteria. More importantly, the court concluded that even after the statute is closed on the year that the study was done, if that faulty study is used to calculate depreciation at any time during their ownership of the property, they are vulnerable.
  2. A cost-benefit analysis of the re-application of cost segregation to their property, if indicated.
  3. An analysis of the estimated dollar benefit associated with the removal of “Ghost” assets from their depreciation schedule.
  4. An analysis of the estimated write-offs available from the assets replaced by the “179D” assets.

After you have determined which one of the groups your client is in, you should begin to evaluate vendors. Ask each engineering firm to include a sample of a completed Cost Segregation Study with their proposal. When you compare proposals, your most important consideration should be the amount of line item detail provided in the actual study.

Detailed line items in a Cost Segregation Study insure maximum immediate cash flow and tax benefit while preventing “Ghost” assets in the future. Also, any IRS concerns about an “inadequate” or “residual” study have been eliminated.

The following example shows how “ghost” assets are created and how they can be removed from a property that has not benefitted from cost segregation.

On June 1, 2009, Building Owner B purchased and is depreciating a $25,000,000 property that was constructed in 2000.  On March 15, 2012, Building Owner B replaced four of the twelve HVAC rooftop units. Without the benefit of having a Cost Segregation Study, these assets were not separately stated and the building was accounted for as a single asset (single line item) with a cost of $25,000,000. The property was depreciated as non-residential real property and used the straight-line method of depreciation with a 39-year recovery period. Because Building Owner B cannot identify the cost of the components of the property from its records, it hires a cost segregation engineering firm to determine the costs of the HVAC units.  It is determined that at the time of purchase the HVAC units were each worth $267,000.  Using the straight-line 39-year depreciation method and mid-month convention, Building Owner B was able to recognize a loss in the current year of $991,551.

Similarly, an inadequate Cost Segregation Study can make it impossible to write-off the undepreciated balance of those four replaced units. If a Cost Segregation Study showed just one $4,500,000 line item, covering all of the HVAC components throughout the property, that is the only detail that will appear on the depreciation schedule. Again, that is not enough detail to write-off the undepreciated balance of $247,888 for each of the four units replaced.

To insure that the study will not only satisfy the IRS, but will also maximize your client’s immediate dollar benefit and prevent the future accumulation of “Ghost” assets, you should insure that their completed Cost Segregation Study will contain as many line items as possible.

While they have until next year to “Tune-Up” their depreciation schedules, their tax savings can begin with their next quarterly tax filing after their depreciation schedule has been “Tuned-Up.”

Michael Donohue

M&E Cost Segregation

THE AUTHOR: Michael Donohue represents M&E Cost Segregation. M&E provides Cost Segregation Studies, Asset Retirement Studies and “179” certifications to commercial real estate owners and their financial advisors. Should you have any questions, he can be reached at [email protected] or (888) 277-8377.