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)

bjohnson@capstantax.com

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