As a result of tangible property regulations passed at the beginning of this year, cost segregation studies have become a popular and effective part of a property owner’s annual tax saving strategy. From its beginnings as an IRS legal memorandum, the practice of employing cost segregation studies in the accounting community has grown and evolved considerably. Early cost segregation studies had to determine whether or not a piece of property could be classified as 1245 or 1250 according to the Internal Revenue Code, an unclear determination that hinged on whether or not an asset or improvement was part of a structural component of a building. Current and expanding practice has become much clearer and gone into more detail to include savings associated with:
• Energy tax deductions for heating and cooling systems, lighting systems, and building envelopes as part of 179D
• Expense of undepreciated property that is reparable or requires ongoing maintenance
One of the primary advantages of current tangible property regulations is the ability to apply depreciation acceleration benefits to properties purchased in a previous tax year. This is because the regulations allow for an automatic change of accounting method that may retroactively address incorrect depreciation of assets where either depreciation was not taken, or where too little was taken. The regulations stipulate specifically that any missed depreciation from the time the asset was placed in service may be deducted in the first year that the new accounting methods are incorporated.
Another clear advantage of today’s tangible property regulations is the utilization of detailed engineering analysis as a part of a cost segregation study to determine exact depreciation expense for retirement of certain property assets, and repair or retirement of equipment and building systems.
Renovations to structural assets of a building must be assessed by a proper engineering study to determine accurate depreciation schedules for said assets. All equipment and machinery that is deemed “functionally independent” or all out of service equipment and infrastructure must be reviewed through auditing of old building plans and tax schedules to determine whether or not there are still undisposed assets sitting on a balance sheet. These items may be written off in the year the leave the property or may even be written off as part of a look back study if they have already been disposed of or sold.
A comprehensive engineering analysis is not just an audit of old equipment or infrastructure though and may be used to establish the value on all structural components of a property in order to expense their retirement during and not just after their functional life. This is, however, separate from the analysis of components that would be considered part of a building system’s repairs or maintenance. These items, once identified as part of a property’s functional maintenance, may have their remaining undepreciated balance written off. Typical building systems that are considered as part of an engineering analysis are HVAC systems, plumbing, gas, and electrical infrastructure, security systems, and any alarms or disaster protection infrastructure.
Tangible Property Regulations and their associated cost segregation studies and engineering analysis have become an integral part of the property ownership landscape. If taken advantage of, they may provide invaluable support to property owners looking to improve or maintain building infrastructure and operating equipment.
Note: There are some important decisions that should be considered before the 2014 return is filed as the IRS is granting an automatic consent for certain changes. After 2014 the process is a little bit more tedious.