cost segregation in the era of tax reformcontent should not be construed as situation-specific tax...
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Cost Segregation in the Era of Tax Reform
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Disclaimer
This information is based on Capstan's understanding of the subject matter; the
content should not be construed as situation-specific tax or legal advice and no
options should be implemented without the validation and approval of your tax
advisor or CPA. As such, the recipient agrees to hold Capstan harmless with
respect to any actual or consequential damages incurred by direct or indirect
utilization of information or strategies contained herein.
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CPE Policy
• Per NASBA regulations you MUST register for webinar and answer all the polling questions.
• CPE certificates will be emailed to those who qualify by the end of next week
Capstan Tax Strategies is registered with the National Association of State Boards of Accountancy (NASBA) as a
sponsor of continuing professional education on the National Registry of CPE Sponsors. State boards of accountancy
have final authority on the acceptance of individual courses for CPE credit. Complaints regarding registered sponsors
may be submitted to the National Registry of CPE Sponsors through its website: www.learningmarket.org.
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About Capstan Tax Strategies
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Partners and staff have over 70 years of combined cost segregation experience
Team has completed over 5,500 successful studies
Commitment to the best practices in the industry
– Full compliance with ASCSP MQS 2016
– IRS ATG
Clearly defined and audit-tested processes and practices
Work primarily through CPA firms
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Today’s Presenter
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Bruce A. Johnson, MBA, CEM
Founding Partner
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Topics for Discussion
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Overview of Cost Segregation
Qualifying Assets
Capstan Case Studies
Recent Developments
Q&A (if time)
Brief Overview of Cost Segregation
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A Quick History
ITC & Component Depreciation
Tax Reform Act of 1986
Hospital Corporation of America v. Commissioner, finalized in 1999
2004 - IRS Audit Techniques Guide (ATG) for cost segregation studies (updated since)
2006 – American Society of Cost Segregation Professionals (ASCSP) established
Major Court Cases:
– PECO Foods, Inc.: Take care in preparing a Purchase Price Allocation (PPA). PPA data takes
precedence over a cost segregation study done after purchase
– AmeriSouth, XXXII, Ltd.: In the event of a audit going to court, be certain to have representation
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Cost Segregation: The Vehicle for Savings
Cost segregation provides the data required to support a
variety of tax strategies
IRS-approved tool that has been in use for years, though
recent legislation has made it more effective than ever
Basic objective: Accelerate depreciation deductions
– Multiple applications/utilities, as we’ll discuss
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Cost Segregation: The Vehicle for Savings
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Commercial property is often depreciated using long (27.5 or 39-year) lives
However, the IRS allows certain assets to be depreciated using shorter
lives – 5, 7, or 15-year
By carving out, or segregating, the assets with shorter lives, depreciation of
those assets may be accelerated
Accelerated depreciation tax deferral increased cash flow
Remember: In cost seg, depreciation isn’t increased, it’s accelerated
– Time value of money
– Value of a dollar today vs. value of same dollar in the future
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Cost Segregation: How Does it Work?
Forensic, engineering-based analysis
MACRS – Modified Accelerated Class Recovery System
Goal – to identify and reallocate assets from long-lived MACRS
classes to shorter-lived MACRS classes
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Real Property (§1250)
“Base Building” – roof,
walls, windows, foundations,
vertical transportation, etc.
39-Year
27.5-Year
15-Year5 or 7-Year
Tangible Personal Property
(§1245)
Land improvements
(§1250)
Land
Not Depreciable
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Cost Segregation: Benefits
Used to maximize and support accelerated depreciation of real
and personal property
Excellent asset management tool
Recognized by the IRS as an accepted procedure – defensible
Increases cash flow – time value of money
– Doesn’t increase depreciation, but accelerates it
Used to establish Unit of Property under Tangible Property Regs
Provides the data required to support a myriad of tax strategies
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Cost Segregation: Timing
A CSS has utility throughout the real estate life cycle:
– Immediately after construction or acquisition, to maximize benefit over the long
term
– Following major capital improvements (including leasehold)
– After a change in ownership
– Buildings already in service (look-back study)
• Tremendous first year savings potential
• File 3115 Change in Accounting Method
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Property Types and Average % Accelerated
Apartments 5 – 35%
Auto Dealers 35 – 60%
Health Care Facilities 20 – 50%
Hotels 20 – 40%
Industrial Buildings 20 – 40%
Manufacturing Facilities 30 – 70%
Office Buildings 10 – 30%
Restaurants 20 – 60%
Shopping Centers 20 – 40%
Tenant Spaces 20 – 60%
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Cost Segregation: Good Candidates
Owners of commercial property or residential rental property
– Generally looking at properties with value of at least $2.5M
Taxpayers that acquire, renovate, or improve real estate
– Acquisition must have taken place after 1/1/87
Renovation projects of at least $200,000 or more
Owners who regularly update their stores or facilities
Clients who have already performed Cost Segregation Studies
– May want to leverage the newer legislation
Clients who have never performed Cost Segregation Studies but now see a broader benefit with the new tax law – ex. smaller properties
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Reasons for Not Doing a Cost Seg
Money comes from institutional investors
LIHTC or HTC investors
A large % of our investors are not interested in tax savings
They don’t have income to shelter
CPA has never told them about this tax strategy – just not aware
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Basic Information Required
Client name, entity name and project name
Property Address
Date of placed in service
– Date of written binding contract for acquisitions or date construction began for new construction/renovations
Basic description (i.e. garden-style multi-family, office). Also include # of units/# of tenants/square footage/# of stories
If acquisition, closing statement and allocation to land
If new construction, final AIA
If look-back, most recent federal tax depreciation schedule
Blueprints for original construction and improvements, if available (not needed for proposal)
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Polling Question ONE
True or False:
The land value is typically EXCLUDED from a cost segregation study
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Examples of Qualifying Assets
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Personal Property: 5-Year Class Life
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Venting and Electrical Hookups
Carpet, Wallpaper, Crown Molding Wood Cabinetry, Countertop Receptacles
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Personal Property: 5-Year Class Life
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Resilient Flooring, Wood Base, Window Treatments
Stainless Steel Sink, Base Cabinets
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Personal Property: 7-Year Class Life
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Office furniture and fixtures, including
desks, files, safes, and more
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15-Year Land Improvements
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Shrubbery, sidewalks, fences, roadways,
parking lots, retaining walls, pools, storm water
retention systems, and more
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Allocation of Soft Costs
Soft costs should be allocated proportionately
– Specialty costs can be allocated on a more specific basis
E.g., Lighting design fees
Soft costs include
– Specialty consulting
– Permitting
– Accounting and legal
– Construction period interest
– General conditions
– Architectural and engineering fees
– Contractor overhead and profit
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Confidential Case Studies
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CASE STUDY |
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Facts Acquisition in current condition – WBC signed after 9/27/2017
Placed-in-Service: 11/7/2018
Two-story office facility, one tenant
100% Bonus in play under TCJA
Basis: $10,380,373
Strategies Implemented: Cost Segregation and Unit of Property Analysis
Results 1st Year Tax Savings: $1,024,358
10 Year NPV: $828,444
Moved 14% to 5-year
Moved 15% to 15-year
Office Building
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CASE STUDY |
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Facts Acquisition in current condition, one tenant – WBC signed after 9/27/2017
One-story building with warehouse space, production areas, receiving bays, office space
Placed-in-Service: 5/15/2018
100% Bonus under the TCJA
Basis: $1,634,000
Strategies Implemented: Cost Segregation and Unit of Property Analysis
Results 1st Year Tax Savings: $123,091
10 Year NPV: $99,242
Moved 11.5% to 7-year
Moved 11.8% to 15-year
Light Manufacturing Facility
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CASE STUDY | Townhouse Apartment Complex
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Facts Acquired in current condition
85 two-story residential buildings, 9 storage buildings, total of 538 apartments
– Two swimming pools, playgrounds, other amenities
Placed-in-Service: 9/20/2018 (WBC signed after 9/27/2017)
100% Bonus in play under TCJA
Basis: $37,455,200
Strategies Implemented: Cost Segregation and Unit of Property Analysis
Results 1st Year Tax Savings: $3,142,872
10 Year NPV: $2,284,089
Moved 18.7% to 5-year
Moved 7% to 15-year
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CASE STUDY | Commercial Office Fit-Out – Tenant Improvements
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Facts
New Construction
Private offices, cubicle areas, conference rooms, server area, entry lobby
Placed-in-Service 2/22/2018 (Construction begun after 9/27/2017)
Basis: $870,519
Strategies Implemented: Cost Segregation and Unit of Property Analysis
Results 1st Year Tax Savings: $98,371
10 Year NPV: $79,186
Moved 28.6% to 5-year
Moved 0.3% to 15-year
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Polling Question TWO
True or False:
Land improvements are classified as 5-year assets.
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Bonus and Qualified Property Categories
Under the Tax Cuts and Jobs Act (TCJA)
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The Tax Cuts and Jobs Act (H.R. 1) [TCJA]
First comprehensive tax reform since 1986 -- tremendous impact on all industries, including CRE
Bonus Depreciation Boosted
Written Binding Contract vs. Substantial Construction – 9/27/2017 is Crucial Date
QIP and Qualified Property Categories Change
Interest Deduction Limitation Established
Section 179 Expensing Expanded
State and Local Deductions Capped
Like-Kind Exchanges of Personal Property No Longer Permitted
179D and 45L Renewed Through Bipartisan Budget Act of 2018
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Bonus Depreciation
Bonus depreciation is a tax incentive that permits an immediate
first-year deduction on the purchase of eligible business assets,
in addition to other depreciation
– Originally introduced in 2001 to stimulate the economy post 9/11
– Since that time, Congress has continued to introduce incentive
legislation that includes Bonus depreciation
Qualified property must have a MACRS class life of 20-years
or less – these assets are isolated through cost seg
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Real Property (§1250)
“Base Building” – roof,
walls, windows, foundations,
vertical transportation, etc.
39-Year
27.5-Year
15-Year5 or 7-Year
Tangible Personal Property
(§1245)
Land improvements
(§1250)
Land
Not Depreciable
Bonus-Eligible Property –
New Construction and Renovation
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Bonus Depreciation Under the TCJA
New construction/renovation assets are eligible
NOW acquired assets are eligible – qualifying
assets no longer have to be new, just “new to
you”
After 2022, Bonus rates will gradually decline
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Bonus Under the TCJA Impacts RESULTS
Manufacturing facility acquired by new owners
Depreciable Basis: $10.8M
30% moved to 5-year
12% moved to 15-year
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Results Before TCJA – No Bonus on Acquisitions
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Results After TCJA – 100% Bonus on Acquisitions
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Bonus Depreciation: Takeaway
The numbers speak for themselves – 100% Bonus is a huge incentive that owners must not overlook
Cost seg is the tool used to document and support segregation of assets into shorter-lived categories, therefore making them eligible for Bonus
Recent legislation has made acquired properties and smaller-basis properties worth re-evaluating – better candidates for study than they were pre-TCJA
– Just because something wasn’t “worth it” before…
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Polling Question THREE
True or False:
100% Bonus depreciation has been extended through 2026.
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Qualified Property Categories
Congress created further incentives – different types of “improvement
property”
Today, only one designation remains – Qualified Improvement
Property (QIP)
However, expired incentives like Qualified Leasehold Improvements
(QLI) may be accessed through a look-back study
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Qualified Improvement Property (QIP)
Def: Any improvement to an interior portion of a building which is
nonresidential real property if the improvement is placed-in-service after the
date the building was first placed-in-service by any taxpayer.
According to most recent legislation --
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QIP placed-in-service after 12/31/2017 is 39-year, and as such is
not eligible for Bonus [remember, only property with a depreciable life of 20-years or less is eligible for Bonus]
*Taxpayers should consult with their tax professional before engaging in any transaction
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Real Property (§1250)
“Base Building” – roof,
walls, windows, foundations,
vertical transportation, etc.
39-Year
27.5-Year
15-Year5 or 7-Year
Tangible Personal Property
(§1245)
Land improvements
(§1250)
Land
Not Depreciable
QIP 39-Year
Bonus-Eligible Currently
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CASE STUDY | Commercial Office Fit-Out – Tenant Improvements
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Facts New Construction
Private offices, cubicle areas, conference rooms, server area, entry lobby
Placed-in-Service 2/22/2018 (Construction begun after 9/27/2017)
Basis: $870,519
Strategies Implemented: Cost Segregation and Unit of Property Analysis
Results Moved 28.6% to 5-year, 0.3% to 15-year
Without Bonus on QIP With Bonus on QIP
1st Year Tax Savings $98,371 $336,299
10 Year NPV $79,186 $270,712
Without Bonus on QIP, Savings Drop by 2/3!
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Qualified Improvement Property (QIP): Takeaways
Bonus-eligible QIP was a boon to property owners and
developers
Without that major incentive, need to source other
deductions and credits to make up the difference
Huge impact when a building is purchased with intent to
renovate (warehouses, manufacturing facilities, hotels,
office buildings)
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Don’t forget about the Tangible Property Regulations
Tangible Property Regs were effective January 1, 2014
Impact whether you expense or capitalize money spent on real estate (and
other tangible property)
The Regs provide guidance regarding:
– Capital expenditures in general
– Amounts paid to acquire tangible property
– Amounts paid to improve tangible property
– Dispositions
– Expensing options
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Routine Maintenance
Safe Harbor
DeMinimis
Safe Harbor
Small Taxpayer
Safe Harbor
Perform activity more than once in a 10 year period
AFS: written policy, $5,000 safe harbor
Non AFS: policy, $2,500 safe harbor
Gross receipts ≤ $10 million, Unadjusted Basis ≤ $1 million,
Deduct the lesser of 2% unadjusted basis or $10,000
EXPENSEExpense
Test
Betterment
Adaptation
Restoration
1. Ameliorates a material condition or defect
2. Material addition to, or a major component of, the Unit of Property
3. Materially increase productivity, efficiency, strength, quality, or output
*If normal wear and tear occur during taxpayer ownership, return to initial state is not a
betterment, If exact replacement is not available, improved but comparable replacement
is not a betterment
1. Replacement of a component of property after properly deducting a loss
2. Replacement of a component that was sold
3. Replacement of property after claiming casualty loss
4. Returns UoP to ordinary, efficient operating condition after deterioration
5. Rebuilding of UoP to like-new condition after end of class life
6. Replacement of major component (40% test) or substantial structural part (25% test)
Adapts UoP to a new or different use from the ordinary use at the time originally placed in
service
Is the expenditure material to
its Unit of Property or material
at the discrete function level
within UoP?
Unit of Property
Building Structure
Building Systems
-HVAC
-Plumbing
-Electrical
-All Escalators/elevators
-Fire protection and alarm system
-Security System
-Gas Distribution System
-Items that have different MACRS lives
Assets within UoP performing a major discrete function
CAPITALIZE
With option to write off
remaining depreciable
basis of existing asset
using Partial Asset
Disposition Election *3
Materiality
Test
NO
YES
NO
EXPENSE
The Tangible Property Regulations Flowchart: Buildings
NO
YES
Does the expenditure
meet an exception to
capitalization?
BAR
Test
Is the expenditure
an improvement to
the building’s
systems or the
building’s structural
components?
YES
* See Reverse for Supplemental Information
or
or
*1
*2
*2 Version 2.0
*3
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Finding Opportunities Under the TCJA
Have you/your client had any recent activity?
– New Construction?
– Acquisition?
– Renovation?
Have you taken advantage of the following?
– Accelerated depreciation through Cost Segregation
– Expensing of eligible assets under the Tangible Property Regulations
– Partial Asset Disposition to dispose of assets retired, replaced, or demolished in a renovation?
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Questions?
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We look forward to working with you!
Bruce A. Johnson
Capstan Tax Strategies
101 West Avenue, Suite 301
Jenkintown, PA 19046
215.885.7510 (o)
215.740.1593 (c)
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