Purchase Price Allocation and Cost Segregation Studies: A ...
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Purchase Price Allocation and Cost Segregation Studies A Team
ApproachPresented by Walter W OrsquoConnell ASA
October 8 2020
1
DisclaimerThe techniques ideas suggestions and other information within this PowerPoint are intended for your GENERAL
KNOWLEDGE only and is not a substitute for formal andor advanced training in the preparation of a lsquoCost Segregation
Studyrsquo Any application of the techniques ideas and suggestions within this PowerPoint is at the participantrsquos
readers sole discretion and risk The information should not be considered lsquocompletersquo and does not qualify the participant(s) of this presentation to perform a Quality Cost Segregation Study
2
Presenter Walter W OrsquoConnell MEc ASA Educationbull BA ndash Economics ndash Kean University of New Jerseybull BS ndash Finance ndash Kean University of New Jerseybull MA ndash Economics ndash Montclair University of New Jerseybull ASA - Machinery amp Technical Specialties
Publishedbull ASA MTS Journalbull Academiaedu
Career Pathbull Buyer Planner amp Forecaster ndash MFG Supplies amp MampEbull Machinery amp Equipment AppraiserCost Segregation Professionalbull Current ASA Philadelphia Chapter Presidentbull Past Co-Chair of the American Society of Cost Segregation Professionals (ASCSP)
3
Presenter
Estimates the High Low Useful Life Range of over 5000 fixed and movable assets within the Lodging IndustryPublished by
331-Pages
4
About the ASAThe American Society of Appraisers is the largest multi-discipline voluntary membership trade association representing and promoting their member appraisers The society was founded in 1936 and is one of the eight trade association appraisal groups that founded The Appraisal Foundation
5
Overview of Cost Segregation What is Tax Depreciation
What is Cost Segregation
Who can benefit from a Cost Segregation Study
Cost Segregation as part of a Purchase Price Allocation
6
Purchase Price Allocation What is the connection between Purchase Price Allocation amp
Cost Segregation
How are lsquoAppraised Valuesrsquo used in a Cost Segregation
How a Cost Segregation Study can be used to lsquoenhancersquo the Fixed Asset Record (FAR)
Repair Regulations Compliance using a Cost Segregation Study
7
Cost Segregation in the Broadest TermsCost Segregation Study Under United States tax laws and accounting rules cost
segregation is the process of identifying personal property assets that are grouped with real propertyassets and separating out personal property for tax reporting purposes
Note The words lsquoAppraisalrsquo andor lsquoValuationrsquo are not found within this definition
8
The Big QuestionsQuestion Are Cost Segregation Studies AppraisalValuation
Assignments Why are we studying this topic Why is a MampE Appraiser instructing on a subject related
to Real Property
9
The Big AnswersQuestion Are Cost Segregation Studies AppraisalValuation
Assignments Answer No Why are we studying this topic Answer Cost Segregation is addressed in the 3rd amp 4th
addition of ldquoValuing Machinery and Equipment The Fundamentals of Appraising Machinery and Technical Assetsrdquo
10
The Big Answers
11
3rd Edition 4th Edition
The Big Answers
12
Why is a MampE Appraiser instructing on a subject related to Real Property Remember Cost Segregation is the process of identifying
personal property assets that are grouped with real property assets
It is as much a lsquoPersonal Propertyrsquo exercise as it as a lsquoReal Property Exercisersquo
Segregation as in lsquoCost Segregationrsquo = Componentization
Why Machinery not Real Property AppraisersMachinery amp Equipment Appraisers are trained
in lsquoComponentrsquo Valuation
13
Cookie Production Line
Why Machinery not Real Property AppraisersMachinery amp Equipment Appraisers are trained
in lsquoComponentrsquo Valuation
14
Cookie Production Line
MampE Appraisers look at dozens or hundreds of lsquocomponentsrsquo to value production lines
Why Machinery not Real Property Appraisers Machinery amp Equipment (lsquoMampErsquo) Appraisers are trained
in the lsquoComponentrsquo Valuation The art of lsquocomponentizingrsquo large production lines into
individual components for the purpose of valuing those assets is similar to lsquosegregatingrsquo commercial real property into their individual components
Componentizing = SegregationSegregating the Costs of lsquoRealrsquo amp lsquoPersonal Propertyrsquo
15
Who Performs Cost Segregation Studies
16
What is Tax Depreciation
A form of depreciation where the loss in value or usefulness of a property is due to the using up or expiration of its useful life caused by wear and tear deterioration exposure to various elements physical stresses and similar factors
17
We know as Appraisers whatPhysical Depreciation
What is Tax DepreciationTax depreciation the depreciation that can be listed as an expense on a tax return for a given reporting period under the applicable tax laws It is used to reduce the taxable income reported by a business Depreciation is the gradual charging to expense of fixed assets cost over its useful life
18
What is Tax DepreciationFixed Assets are Assets which are purchased
for long-term use and are not likely to be converted quickly into cash such as land buildings and equipmentAll legal Fixed Assets are allowed to be
depreciated for Business with exception of LandLand is Never Depreciable
19
What is Tax DepreciationLand is non-depreciated because land is assumed to have an unlimited useful life Other long-lived Fixed assets such as land improvements buildings furnishings equipment etc have limited useful lives Therefore the costs of those assets must be allocated to those limited accounting periods
20
What is Tax DepreciationLand may change overtime by Man or Nature but can never be exhausted
21
Your Land is now at the Bottom of the Sinkhole
What is Tax Depreciation
Land may change overtime by Man or Nature but can never be exhausted
22
Your Land is now at the Bottom of the Lake
Tax Depreciation History Tax Depreciation is loosely based on Physical Depreciation using the
lsquoAsset Depreciation Range System (ADR)rsquo developed by the InternalRevenue Service (ldquoIRSrdquo)
US Income Tax signed into law 1913 (Fund The Great War (WWI)) It was like the Wild Wild West Making depreciation rules up as you go Some non-governmental sources like Tiffanyrsquos Digest of Depreciation 1890
edition gave some guidance 1934 The U S Treasury due to decreased revenue began requiring taxpayers
to prove that they were selecting appropriate useful lives Giving little guidance and relying on non-governmental sources (The US Great Depreciation)
23
Tax Depreciation History 1942 Bulletin F Tables of Useful Lives of Depreciable Property The first true
guidance published by the IRS 1954 Congress authorized the use of accelerated depreciation methods (We will
speak about this later Very Important) 1971 The class life was introduced This provided for tax depreciation based on
lsquoclass livesrsquo 1981 The Accelerated Cost Recovery System (ACRS) was designed to simplify
cost and recovery and stimulate capital formation 1986 Modified Accelerated Cost Recovery System (MACRS) was an entirely
new system for tangible property placed into service after 1986 (economic stimulus to stimulate spending)
`
24
When did Cost Segregation Studies BeginA Cost Segregation Study
(Real Property Reclassification Exercise)was not created under one sweeping lsquoTax Actrsquo or lsquoRegulatory Changersquo It was a slow progression
bull US Income Tax signed into law 1913 (fundfinance lsquoThe Great Warrsquo ndash lsquoWorld War Irsquo (1914 ndash 1918)bull Development of IRS Depreciation Tables 1954bull Development of Class Lives 1971bull Asset Depreciation Range System (ADR) 1971bull Accelerated Cost Recovery System (ACRS) 1981 (Economic Stimulus)bull Reagan Economic Recovery Act (1981)bull Reagan Tax Reform Act (1986)bull Modified Accelerated Cost Recovery System (MACRS) 1986 (Economic Stimulus)bull A Major Tax Court Case HOSPITAL CORP OF AMERICA v COMMISSIONER 1997 (Tax Court)
25
What is a Cost Segregation StudyCost Segregation is the process of identifying personal property assets that are grouped with commercial real property assets and separating out those personal assets for tax reporting purposes (IRS)
In-Short We are identifying commercial real property components that are Considered personal property
or Directly support personal property
For the purpose of reclassifying those assets to shorter-lived depreciation (Walter OrsquoConnell)
26
How is Real Property DepreciatedldquoIn order to calculate depreciation for Federal income tax purposes taxpayers must use the correct method and proper recovery period for each asset or property ownedrdquo Non-Residential Commercial Real Property 1250-39 (39-year)
Depreciation
Residential Commercial Real Property 1250-275 (275-year) Depreciation
Commercial Real Property Site Improvements 1250-15 (15-year) Depreciation
IRS ndash Cost Segregation Audit Techniques Guide Chapter 1 ndash Introductionhttpswwwirsgovbusinessescost-segregation-audit-techniques-guide-chapter-1-introduction
27
How is Real Property DepreciatedIf no Cost Segregation Study is performed the IRS Income Tax
Filing must be 39-Year lsquoStraight-Linersquo Depreciation for Non-Residential
Commercial Property (1250-39) (39-year)
275-Year lsquoStraight-Linersquo Depreciation for Residential Commercial Property (1250-275) (275-year)
15-Year lsquoStraight-Linersquo Depreciation for Site Improvements associated with All Commercial Property (1250-15 )(15-year)
28
How is Real Property DepreciatedWhat Does 1250 Mean
Section 1250 of the United States Internal Revenue Code is a rule establishing that the IRS will tax a gain from the sale of depreciated commercial real property as ordinary income if the accumulated depreciation exceeds the depreciation calculated with the straight-line depreciation method
29
1250-15 1250-275 1250-39 Site Improvement Commercial Residential Commercial Non-Residential
15-Year 275-Year 39-Year
How is Real Property DepreciatedA lsquoCommercial Parking Lotrsquo (Site Improvements (1250-15)) is PurchasedBuilt for $18000000 Appraised Land Value = $3000000 (Land is never depreciated) Basis $18000000 ndash $3000000 = $15000000
30
$1000000 $1000000 $1000000 $1000000 $1000000
$1000000 $1000000 $1000000 $1000000 $1000000
$1000000 $1000000 $1000000 $1000000 $1000000
Annual Straight-Line Depreciation 15-Years
How is Real Property DepreciatedA lsquoCommercial Apartment Buildingrsquo (Residential Commercial Property (1250-275)) is PurchasedBuilt for $35000000 Appraised Land Value = $7500000 (Land is never depreciated) Basis $35000000 ndash $7500000 = $27500000
31
Annual Straight-Line Depreciation 275-Years$1000000 $1000000 $1000000 $1000000 $1000000
$1000000 $1000000 $1000000 $1000000 $1000000
$1000000 $1000000 $1000000 $1000000 $1000000
$1000000 $1000000 $1000000 $1000000 $1000000
$1000000 $1000000 $1000000 $1000000 $1000000
$1000000 $1000000 $ 500000
How is Real Property DepreciatedA lsquoCommercial Office Buildingrsquo (Non-Residential Commercial Property (1250-39)) is PurchasedBuilt for $44000000 Appraised Land Value = $5000000 (Land is never depreciated) Basis $44000000 ndash $5000000 = $39000000
32
Annual Straight-Line Depreciation 39-Years$1000000 $1000000 $1000000 $1000000 $1000000
$1000000 $1000000 $1000000 $1000000 $1000000
$1000000 $1000000 $1000000 $1000000 $1000000
$1000000 $1000000 $1000000 $1000000 $1000000
$1000000 $1000000 $1000000 $1000000 $1000000
$1000000 $1000000 $1000000 $1000000 $1000000
$1000000 $1000000 $1000000 $1000000 $1000000
$1000000 $1000000 $1000000 $1000000
Cost Segregation In-PracticeTheory of Cost Segregation
A Cost Segregation Study does not increase or decrease the depreciation that can be taken on a lsquocommercial propertyrsquo We are shifting depreciation of commercial real property components that
areConsidered personal property
orDirectly support personal property
and moving (Shifting) that depreciation from future years of lsquoexpensingrsquo to more current years of expensingrsquo
33
Cost Segregation In-PracticeExample of the lsquoShiftrsquoAn lsquoOffice Building with Site Improvementsrsquo is PurchasedBuilt for $50000000Appraised Land Value = $11000000Basis $50000000 ndash $11000000 = $39000000
The Cost Segregation Professional performing a quality study that will pass IRS scrutiny moves
10 of the Basis to Short-Lived Property (5-Years Depreciation)10 of the Basis to 1250-15 Site Property (15-Year Depreciation)What will that look like
34
Example of the lsquoShiftrsquo
35
Straight-Line Depreciation
$1000000 $1000000 $1000000 $1000000 $1000000
$1000000 $1000000 $1000000 $1000000 $1000000
$1000000 $1000000 $1000000 $1000000 $1000000
$1000000 $1000000 $1000000 $1000000 $1000000
$1000000 $1000000 $1000000 $1000000 $1000000
$1000000 $1000000 $1000000 $1000000 $1000000
$1000000 $1000000 $1000000 $1000000 $1000000
$1000000 $1000000 $1000000 $1000000
$ 1840000 $ 1840000 $ 1840000 $ 1840000 $ 1840000
$ 1060000 $ 1060000 $ 1060000 $ 1060000 $ 1060000
$ 1060000 $ 1060000 $ 1060000 $ 1060000 $ 1060000
$ 800000 $ 800000 $ 800000 $ 800000 $ 800000
$ 800000 $ 800000 $ 800000 $ 800000 $ 800000
$ 800000 $ 800000 $ 800000 $ 800000 $ 800000
$ 800000 $ 800000 $ 800000 $ 800000 $ 800000
$ 800000 $ 800000 $ 800000 $ 800000
Accelerated Depreciation
$ 5000000 Years 1 thru 5$10000000 Years 6 thru 15$24000000 Years 16 thru 39
$ 9200000 Years 1 thru 5$10600000 Years 6 thru 15$19200000 Years 16 thru 39
10 Moved to 5-Year10 Moved to 15-Year
Depreciation
So Whathellip Who CareshellipThe Property Owner still only gets $39000000 of Depreciation
($50000000 - $110000 (Land) = $39000000)This is why we care and perform Cost Segregation Studies 1 Do you want a bigger tax refund today when the dollar ($) has the
buying power of a dollar ($) or in future when the dollar ($) has decreased buying power
2 Will the owner own the Property 39-Years or 275-Years from now3 As a BusinessInvestment Opportunity would you not want a
larger tax refund today not in the future so you can reinvest those savings into your business (Investment Opportunity)
36
Can we measure the Benefit of a StudyThe Answer is YesThe BenefitSavings can be measured as Net Present Value (NPV) Tax Savings
37
i = What is the discount rate within your industry(industry Rate of Return)
t = The time period (years) you could reinvest those additional tax refund dollars ($) froma quality Cost Segregation Study
What would the NPV Tax Benefit be
38
Straight-Line Depreciation
$1000000 $1000000 $1000000 $1000000 $1000000
$1000000 $1000000 $1000000 $1000000 $1000000
$1000000 $1000000 $1000000 $1000000 $1000000
$1000000 $1000000 $1000000 $1000000 $1000000
$1000000 $1000000 $1000000 $1000000 $1000000
$1000000 $1000000 $1000000 $1000000 $1000000
$1000000 $1000000 $1000000 $1000000 $1000000
$1000000 $1000000 $1000000 $1000000
$ 1840000 $ 1840000 $ 1840000 $ 1840000 $ 1840000
$ 1060000 $ 1060000 $ 1060000 $ 1060000 $ 1060000
$ 1060000 $ 1060000 $ 1060000 $ 1060000 $ 1060000
$ 800000 $ 800000 $ 800000 $ 800000 $ 800000
$ 800000 $ 800000 $ 800000 $ 800000 $ 800000
$ 800000 $ 800000 $ 800000 $ 800000 $ 800000
$ 800000 $ 800000 $ 800000 $ 800000 $ 800000
$ 800000 $ 800000 $ 800000 $ 800000
Accelerated Depreciation
$ 5000000 Years 1 thru 5$10000000 Years 6 thru 15$24000000 Years 16 thru 39
$ 9200000 Years 1 thru 5$10600000 Years 6 thru 15$19200000 Years 16 thru 39
10 Moved to 5-Year10 Moved to 15-Year
Depreciation
What would the NPV Tax Benefit be
39
DataIndustry Office BuildingBasis $39000000 ($50000000 - $11000000)Industry Discount Rate (Return on Investment) 6Current CorporateCompany Tax Rate (US andor State) 33
Net Present Value Tax Savings$1303031
The Goal The Goal of a Cost Segregation Study is to identify and
reclassifyLong-Lived Section 1250-15 1250-275 1250-39
to1245 Short Lived Property
(Intangible or Tangible Personal Property)
40
What is 1245 lsquoShort Livedrsquo PropertySection 1245 property is defined as intangible or tangible personal property that could be or is subject to depreciation or amortization excluding buildings (real estate)(1250-Property) and structural componentsRemember Building Components that are Considered Personal Property or Directly Support Personal Property
We will discuss and give examples of lsquoshort-livedrsquo property later in the presentation
41
Short History ndash MACRS amp The Asset Depreciation Range (ADR)Highlights Before 1981 it was the Wild Wild West for Commercial
Real Property Tax Depreciation The guidance given by the IRS was short and simple
Depreciation methods amp lives were not as defined as they are today The IRS allowed Taxpayers to select lsquoRecovery Periodsrsquo they deemed lsquoReasonablersquo It was only lsquounder auditrsquo that a recovery period could be disallowed
42
Short History ndash MACRS amp The Asset Depreciation Range (ADR)Highlights The Reagan Tax Cuts
bull 1981 ndash The Economic Recovery Tax Act of 1981o Personal Income Tax Upper Rate fell from 70 to 50
bull 1986 ndash The Tax Reform Act of 1986o Personal Income Tax Upper Rate fell from 50 to 385
43
Short History ndash MACRS amp The Asset Depreciation Range (ADR)Highlights The Reagan Tax Cuts
bull Congress fearing the Tax Cuts that they passed into law would not generate enough taxable income to keep government running
1 Enacted the lsquoAccelerated Cost Recovery Systemrsquo (ACRS) 1981 (Economic Stimulus) for lsquoNon-Real Propertyrsquo ie lsquoMampErsquo FFampE
2 Fixing both lsquoCommercial Residential Propertyrsquo and lsquoCommercial Non-Residential Propertyrsquo at 315-Year Straight-Line Depreciation
3 Disallowed any lsquoAccelerated Depreciationrsquo of Commercial Real Property
44
Short History ndash MACRS amp The Asset Depreciation Range (ADR)Highlights The Reagan Tax Cuts
bull Congress later replaced the lsquoAccelerated Cost Recovery Systemrsquo (ACRS) with a new Modified Accelerated Cost Recovery System (MACRS) (Economic Stimulus) in 1986
1 Passed as an lsquoEconomic Stimulus Packagersquo allowing to quicker depreciation of lsquoPersonal Propertyrsquo
2 Commercial Non-Residential Real Property was set at 39-Year Straight-Line Depreciation (Formally 315-year)
3 Commercial Residential Real Property was set at 275-Year Straight-Line Depreciation (Formally 315-year)
4 Commercial Real Property Site Improvements were set at 15-Year Straight-Line Depreciation
5 Still disallowed lsquoAccelerated Depreciationrsquo of Commercial Real Property
45
Short History ndash MACRS amp The Asset Depreciation Range (ADR)Straight-Line Depreciation was the Law-of-Land for Commercial Real Property from 1981 thru 1997 (16-Years)
Then cameHOSPITAL CORPORATION OF AMERICA v IRS COMMISSIONER
46
v
Short History ndash MACRS amp The Asset Depreciation Range (ADR)Hospital Corporation of America (lsquoHCArsquo)
47
Kitchen hoods and exhaust SystemPatient corridor handrailsOver-bed fluorescent lightsPartitionsroom dividersBathroom accessoriesAcoustical ceilingsSteam boilersPrimary and secondary electrical distribution systemSpecial electrical equip and branch wiringTV equipment and wiringTelephone equip wiring jacks and intercom equipmentCarpetingVinyl wall coveringVinyl floor coveringKitchen water piping grease trap system and steam lines
The Tax Courts agreed with HCA that much of the Property lsquoAppearedrsquo to be short-lived property Property that would lsquoneed to be replaced in less then 39-Years (1250-39) but did not have the lsquoexpertisersquo to rule on which property was to be considered lsquoshort-livedrsquo and lsquolong-livedrsquo property
The IRS was instructed to develop a system to address the problem
Over a year later the IRS had not taken any significant action and was told they would be held in Contempt of Court if no action was taken
Partial List of Property Considered Short Lived by HCA
Short History ndash MACRS amp The Asset Depreciation Range (ADR)Hospital Corporation of America (lsquoHCArsquo)
48
The IRS rather then develop a new depreciation system looked to MACRS for the Solution
Allowing for MACRS amp The Asset Depreciation Range (ADR) to be used for Personal Property but for these new Personal Property Assets associated with Commercial Real Property
Short History ndash MACRS amp The Asset Depreciation Range (ADR)Straight-Line Depreciation was the Law-of-Land for
49
Kitchen hoods and exhaust (sect1245)Patient corridor handrails (sect1245)Over-bed fluorescent lights (sect1250)Partitionsroom dividers (sect1245)Bathroom accessories (sect1250)Acoustical ceilings (sect1250)Steam boilers (sect1250)Primary and secondary electrical distribution sys (sect1245sect1250)Special electrical equip and branch wiring (sect1245)TV equipment and wiring (sect1245)Telephone equip wiring jacks and intercom equip (sect1245)Carpeting (sect1245)Vinyl wall covering (sect1245)Vinyl floor covering (sect1245)Kitchen water piping grease trap system and steam lines (sect1245)
Look how Successful HCA was
Cost Segregation is born 1997There were other similar Tax Court Cases before HCA but
this is considered the Seminal Case
50
bull United Kingdom returns Hong Kong and the New Territories to the Peoples Republic of Chinabull Diana Princess of Wales dies in a car crash in a road tunnel in Parisbull Googlecom is registered as a domain namebull Apple Computer Inc names co-founder Steve Jobs interim CEObull Scientists announce the first human stem cells to be cultured in a laboratory
Wildhellip Wildhellip West Once AgainAccountants CPArsquos and Other Tax Professional were Leary of using this new lsquotax saving toolrsquo because of the lack of guidance by the IRS Like lsquoPre-1981rsquo Tax Professionals were lsquomaking it uprsquo as they went many times failing under IRS Audit and incurring heavy fines and penalties
It was considered lsquoHigh Riskrsquo and that lsquoRiskrsquo outweighed the lsquoBenefitsrsquo
51
Cost Segregation lsquoStandardizedrsquoIn 2004 The IRS published the first lsquotruersquo guidance associated with Cost Segregation The lsquoIRS Cost Segregation Audit Techniques Guidersquo was published for Auditors within the IRS Though not published for the Tax Professional (lsquoConsumerrsquorsquoTax Payerrsquo) this guide obtained through the lsquofreedom of information actrsquo allowed the Tax Professional and Cost Segregation Engineer to read and understand the positions taken by the IRS
52
Cost Segregation Audit Techniques GuidePURPOSE OF THE COST SEGREGATION AUDIT TECHNIQUES GUIDEThis Audit Techniques Guide (ATG) has been developed to assist Internal Revenue Service (lsquothe Servicersquo) Examiners in the review and examination of cost segregation studies The primary goal of the guide is to provide examiners with an understanding of1Why cost segregation studies are performed for Federal income tax purposes2How cost segregation studies are prepared3What to look for in the review and examination of these studies and4When certain issues identified in the cost segregation study need further
examination
53
Cost Segregation Audit Techniques Guide Legal Framework Cost Segregation Approaches (Engineering Rules) Principal Elements of a Quality Cost Segregation Study Principal Elements of a Quality Cost Segregation Report Review and Examination of a Cost Segregation Study Uniform Capitalization Change in Accounting Method Depreciation Overview Relevant Court Cases Inherently Permanent Standard (Permanency Test)
54
Cost Segregation Audit Techniques Guide Construction Process Information Document Requests Casinos Restaurants Retail Industries Biotech amp Pharmaceutical Industry Auto Dealerships Auto Manufacturing Electrical Distribution System Stand-Alone Open-Air Parking Structure
55
Cost Segregation Audit Techniques GuidelsquoQualityrsquo
ldquoA lsquoqualityrsquo cost segregation study is a study that is both accurate and well-documentedhelliphelliphelliprdquo Quality
studies greatly expedite the Servicersquos review thereby minimizing the audit burden on all
parties A quality study contains a number of characteristicshelliphelliprdquo
56
IRS Cost Segregation Study Methods Detailed Engineering Approach from Actual Cost Records (New
Construction Real Property) Detailed Engineering Cost Estimate Approach (Acquired Real Property) Survey or Letter Approach Residual Estimation Approach (Acquired Real Property) Sampling or Modeling Approach Rule of Thumb Approach (Pre-1981 Approach)An examiner should view this approach with caution since it lacks sufficient documentation to support its allocation of project costsIRS ndash Cost Segregation Audit Techniques Guide Chapter 5 - Review and Examination of a Cost Segregation Study httpswwwirsgovbusinessescost-segregation-audit-techniques-guide-chapter-5-review-and-examination-of-a-cost-segregation-study
57
IRS Cost Segregation Study Methods
58
The IRS Cost Segregation Audit Techniques Guide which gives guidance to IRS Agents Auditors and Engineers states
The Engineering Approach is ldquothe most methodical and accurate approachrdquo
IRS ndash Cost Segregation Audit Techniques Guide Chapter 3 - Cost Segregation Approacheswwwirsgovbusinessescost-segregation-audit-techniques-guide-chapter-3-cost-segregation-approaches
IRS Cost Segregation Study Methods
59
bull Detailed Engineering Approach from Actual Cost Records
bull Detailed Engineering Cost Estimate Approach
bull Survey or Letter Approach(Not Preferred No engineering support)
bull Residual Estimation ApproachEngineered Approach can be incorporated into this method (lsquoAcquired Property)
bull Sampling or Modeling ApproachEngineered Approach can be incorporated into this method
Engineering1 Obtain information on all direct and indirect project costs
bull Direct Costs = Direct Construction Costs (Roof Walls Casework)bull Indirect Costs = Non-Specific Construction Costs (Accounting Legal Permits)
2 Conduct a Site Visit to inspect the propertybull Measure Photograph Inventory Discussions with Engineers Property Mgt
3 Review All Documents bull As-Built plans specifications contracts bid documents contractor pay requests
change order detail and any other construction cost information or documentation that is available
You will likely not obtain all of the above but an attempt should be made as part of your due diligence
60
IRS Cost Segregation Study Methods
61
If you attempt tobull Obtain information on all direct and indirect project
costsbull Conduct a site visit to inspect the propertybull Review all documents available
You can be successful if placed under IRS Audit Residual Estimation Approach
Engineered Approach can be incorporated into this method (lsquoAcquired Property)
Sampling or Modeling ApproachEngineered Approach can be incorporated into this method
Permanency TestHow does the IRS determine short-lived vs long lived Property Is the property capable of being moved and has it in fact been moved Is the property designed or constructed to remain permanently in
place Are there circumstances which tend to show the expected or intended
lengths of affixation ie are there circumstances which show that the property may or will have to be moved
How substantial of a job is the removal of a property and how time-consuming is it Is it ldquoreadily removablerdquo
How much damage will the property sustain upon its removal What is the manner of affixation of the property to the land
62
Permanency TestThe Internal Revenue Service determines what Property (building components) are lsquoPermanently Affixedrsquo (Real
Property) or lsquoEasily Removedrsquo (Personal Property)Based on
IRS Case Studies Private Letter Rulings Tax Court Rulings
Private Letter Ruling are answers to questions asked by the Taxpayer to the IRS
63
MACRS and ADR SystemsModified Adjusted Cost Recovery System (MACRS) 1986 Asset Depreciation
Range System (ADR) 1971 3-year class- ADR midpoints for 4 years or less ndash Racehorses amp special tools 5-year class - ADR midpoints 4-10 years ndash Most Commercial Personal Property Automobiles
light trucks computers typewriters copiers and duplicating Equipment 7-year class - ADR midpoints 10 - 16 years ndash Most Manufacturing Office furniture amp fixtures
equipment and railroad tracks 10-year class - ADR midpoints 10 - 16 years which includes Various machinery petroleum
distilling and refining 15-year class - ADR midpoints 20 - 25 years which includes Most Site Improvements Sewage
treatment plants 20-year class - ADR midpoints 25 years or more which includes Service stations and other
declining balance real property 275-year class-Residential Commercial Real Property 39-year class-Nonresidential Commercial Real Property
64
Asset Depreciation Range (ADR) System 5-year class - ADR midpoints 4-10 years ndash Most Commercial Personal Property
Automobiles light trucks computers typewriters copiers and duplicating Equipment 7-year class - ADR midpoints 10 - 16 years ndash Most Manufacturing Office furniture amp
fixtures equipment and railroad tracks 15-year class - ADR midpoints 20 - 25 years which includes Most Site Improvements
Sewage treatment plants 275-year class-Residential Commercial Real Property 39-year class-Nonresidential Commercial Real Property
65
Asset depreciation range assigned upper and lower limits to the physical estimated useful lives of asset classes It gave businesses a lot of flexibility to determine the useful life of an asset
Remember lsquoTax Depreciation is loosely based on Physical Depreciationrsquo
MACRSModified Adjusted Cost Recovery System (MACRS) 5-year class - ADR midpoints 4-10 years (Mid-Point = 7-years) 7-year class - ADR midpoints 10 - 16 years (Mid-Point = 13-years) 15-year class - ADR midpoints 20 - 25 years (Mid-Point= 225 years) 275-year class 39-year class
66
As we stated before MACRES was designed as an lsquoEconomic Stimulus Toolrsquo 5-Year Depreciation vs 7-Year Depreciation 7-Year Depreciation vs 13-Year Depreciation
15-Year Depreciation vs 225-Year Depreciation
1245 (Personal) or 1250 (Real) PropertyIn determining if a property is Personal Property or a Building Component the IRS looks at 3-primary factors1 The Permanence Test2 MACRS - The Asset Depreciation Range (ADR) System
bull Building Componentsbull Personal Property that Directly Supports Personal Property
3 Is a Building Component part of ldquothe structural shell of the building and all integral parts thereofrdquobull Normal heatingbull Normal plumbingbull Normal air conditioningbull Fire preventionbull Power requirementsbull Equipment such as elevators and escalators
67
1245-5 amp 7 Year Property
68
Considered Personal PropertyMillwork Curtains and Drapes
Wood Trim Postal Specialties
Prefinished Paneling Protective Wall Covering
Windows Special Purpose Wallpaper
Automatic Door Openers Directories
Mirrors Specialty Lock Sets
Carpeting Interior Signage
Vinyl Flooring Fire Extinguisher Cabinet
Computer Access Flooring Retail Casework amp Displays
Patient Headwall Operable Partitions
Lockers Crown amp Chair Molding
General Rule Non-Manufacturing Commercial 1245-5 Year Property (Commercial Non-Manufacturing)Manufacturing Commercial 1245-7 Year Property (Commercial Manufacturing)
1245-5 amp 7 Year Property
69
Support Personal PropertyHalf Walls Non-Primary Lighting
Computer Room Air Condit Food Service Vents
Walk-In Coolers amp Freezers Medical Exhaust Systems
Plumbing ndash Food Service Eq Data Outlets amp Wire
Plumbing ndash Manufacturing Eq Telephone Outlets amp Wire
Electrical ndash Office Equipment Manufacturing Concrete Floor
Electrical ndash Communications Public Address Systems
Electrical ndash Food Service Eq Nurse Call Systems
Electrical ndash Retail Equipment Laundry Chutes
Electrical ndash Laundry Eq Audio-Visual Outlets amp Wire
Electrical ndash Medical Eq Medical Gas Piping
General Rule Non-Manufacturing Commercial 1245-5 Year Property (Commercial Non-Manufacturing)Manufacturing Commercial 1245-7 Year Property (Commercial Manufacturing)
1250-15 Year Property
70
15-Year Site ImprovementsSite Concrete Asphalt Paving
Site Masonry Sprinkler Irrigation Systems
Exterior Signage Storm Sewer Systems
Swimming Pools Site Signage
Fountains Brick Walls amp Paving
Parking Lamps Patios
Landscaping Traffic Control Equipment
Retention Ponds Site Electrical
Sidewalks Site Plumbing
Curbs Fixed-In-Place Furniture
Fencing amp Gates Retaining Walls
New Construction ndash AIA Construction DocumentsFormal Building Construction Payment Applications Issued by the American Institute of Architects is the most common document detailing new construction
71
G702 APPLICATION FOR PAYMENT G703 CONTINUATION SHEET
AIA G702 Application For Payment
72
One Sheet Showing Total Basis ($) of the Construction
AIA G703 Construction Sheet
73
One or many Sheets showing Construction by type of work performedDozens or hundreds of Asset Detail Lines can be in one Cost Segregation
Assignment Based on the size scope and detail the General Contractor (lsquoGCrsquo) provides
Simple G703 Construction Sheet
74
bull Small Office Buildingbull New Constructionbull Construction Cost (Land Excluded)
$1000000bull Location (Manhattan NY)
Asset Cost Excavation (Foundation Only) $ 5000000 500Foundation (Concrete Block amp Mortar) $ 7500000 750Masonry (Concrete Block amp Mortar) $ 7500000 750Concrete (Floor) $ 7500000 750Flooring (Mix Carpet Vinyl Tile Ceramic) $ 7500000 750Ceilings (Gypsum) $ 5000000 500Wood Plastics and Composites (Interior Fit-Out) $ 12500000 1250Wood Trim $ 5000000 500Plumbing $ 7500000 750Heating Ventilating and Air Conditioning (HVAC) $ 7500000 750Electrical $ 7500000 750Thermal and Moisture Protection (Roof amp Exterior Walls) $ 7500000 750Elevators $ 2500000 250Exterior Improvements $ 10000000 1000Total Improvements $ 100000000 10000
Cost Segregation New Construction Mini Study
75
With no Quality Cost Segregation Study
Asset Cost YearExcavation (Foundation Only) $ 5000000 500 39Foundation (Concrete Block amp Mortar) $ 7500000 750 39Masonry (Concrete Block amp Mortar) $ 7500000 750 39Concrete (Floor) $ 7500000 750 39Flooring (Mix Carpet Vinyl Tile Ceramic) $ 7500000 750 39Ceilings (Gypsum) $ 5000000 500 39Wood Plastics and Composites (Interior Fit-Out) $ 12500000 1250 39Wood Trim $ 5000000 500 39Plumbing $ 7500000 750 39Heating Ventilating and Air Conditioning (HVAC) $ 7500000 750 39Electrical $ 7500000 750 39Thermal and Moisture Protection (Roof amp Exterior Walls) $ 7500000 750 39Elevators $ 2500000 250 39Exterior Improvements (Needs to be Verified) $ 10000000 1000 39Total Improvements $ 100000000 10000
bull Small Office Buildingbull New Constructionbull Construction Cost
(Land Excluded)$1000000
bull Location (Manhattan NY)
Cost Segregation New Construction Mini Study
76
Now What The GC didnrsquot give us a lot of detail1 Obtain information on all direct and indirect project costs
Direct Costs = Direct Construction Costs (Roof Walls Casework)Indirect Costs = Non-Specific Construction Costs (Accounting Legal Permits)
2 Conduct a Site Visit to inspect the propertyMeasure Photograph Inventory Discussions with Engineers Property Mgt
3 Review All Documents As-Built plans specifications contracts bid documents contractor pay requests change order detail and any other construction cost information or documentation that is available Keep It Simple
In this exercise 1) No additional Information can be provided from the GC and 3) No Documents are availableWe must Rely on 2) Site Visit information we can collect
Keeping Our Example Simple
77
Perform a Site VisitConduct a Site Visit to inspect the property
bull Measurebull Photographbull Inventorybull Discussions with Engineersbull Discussions with Property Management
78
We Observed
79
Asset Cost Year NoteExcavation (Foundation Only) $ 5000000 500 39 Basement Only (1250)Foundation (Concrete Block amp Mortar) $ 7500000 750 39 Building Only (1250)Masonry (Concrete Block amp Mortar) $ 7500000 750 39 Building Only (1250)Concrete (Floor) $ 7500000 750 39 Floor (1250)Flooring (Mix Carpet Vinyl Tile Ceramic) $ 7500000 750 539 Mix (1245 amp 1250)Ceilings (Gypsum) $ 5000000 500 39 Gypsum (1250)Wood Plastics and Composites (Interior Fit-Out) $ 12500000 1250 539 Mix (1245 amp 1250)Wood Trim $ 5000000 500 539 Mix (1245 amp 1250)Plumbing $ 7500000 750 539 Plumbing (1245 amp 1250)Heating Ventilating and Air Conditioning (HVAC) $ 7500000 750 539 (HVAC) (1245 amp 1250)Electrical $ 7500000 750 539 Electrical (1245 amp 1250)Thermal and Moisture Protection (Roof amp Exterior Walls) $ 7500000 750 39 Building Only (1250)Elevators $ 2500000 250 39 Elevators (1250)Exterior Improvements $ 10000000 1000 39 Improvements (1250)Total Improvements $ 100000000 10000
Flooring Observed Carpet
Vinyl Tile
Ceramic Tile
80
5-Year Property ndash 3432 SF
5-Year Property ndash 1040 SF
39-Year Property(Observed but did not measure)Residual Approach
Flooring Observed Carpet
Vinyl Tile
Ceramic Tile
81
5-Year Property ndash 3432 SF3432 SF = $25740
5-Year Property ndash 4192 SF1040 SF = $4680
39-Year Property(Observed but did not measure)Residual Approach
How Did You Price That
82
National Pricing Resources
Gordian (RS Means Cost Data Marshall amp Swift - CoreLogisBest 1245 Property Detail Best 1250 Property Detail
lsquoSegregated Cost Methodrsquo
bull Electricalbull Plumbingbull Interiorbull Site
lsquoComponent Pricingrsquo
How Did You Price That
83
National Pricing Resources
Gordian (RS Means Cost DataBest 1245 Property Detail
bull Electricalbull Plumbingbull Interiorbull Site
lsquoComponent Pricingrsquo
How Did You Price That
84
Marshall amp Swift - CoreLogisBest 1250 Property Detail
lsquoSegregated Cost MethodrsquoOffice BuildingClass lsquoCrsquoGood Construction$167 SF
How Did You Price That
85
Base Building ConstructionExcavation (Foundation Only)Foundation (Concrete Block amp Mortar)Masonry (Concrete Block amp Mortar)Concrete (Floor)Flooring (Mix Carpet Vinyl Tile Ceramic)Ceilings (Gypsum)Wood Plastics and Composites (Interior Fit-Out)Wood TrimPlumbingHeating Ventilating and Air Conditioning (HVAC)ElectricalThermal and Moisture Protection (Roof amp Exterior Walls)ElevatorsExterior ImprovementsTotal Improvements
Flooring Observed Was
Now
86
Asset Cost Year NoteFlooring (Mix Carpet Vinyl Tile Ceramic) $ 7500000 750 539 Mix (1245 amp 1250)
Was Was Now NowAsset Cost Year Year NoteCarpet 2574000$ 257 5 Considered Personal PropertyVinyl Flooring 468000$ 047 5 Considered Personal PropertyCeramic Tile Flooring 4458000$ 750 539 446 39 Mix (1245 amp 1250)
$25740 + $4680 + $44580 = $75000
Flooring Observed Carpet
Vinyl Tile
87
5-Year Property ndash 3432 SF3432 SF = $25740SF X Unit Price X Location Adj = Total Cost3432 SF X $500 X 150 = $25740
5-Year Property ndash 1040 SF1040 SF = $4680SF X Unit Price X Location Adj = Total Cost 1040 SF X $300 X 150 = $4680
Rounded to Nearest US Dollar ($) for Example Purposes Only
Location Factor Two CitiesAlbuquerque New Mexico amp Seattle Washington
88
Different Locations have different cost of labor amp cost of materials
Wood Plastics and Composites (Interior Fit-Out)
89
Base amp Wall Cabinets and Countertops Reception Desk5-Year 5-Year
Price amp Location Adjustment
Wood Plastics and Composites (Interior Fit-Out) Was
90
Asset Cost Year NoteWood Plastics and Composites (Interior Fit-Out) $ 12500000 1250 539 Mix (1245 amp 1250)
NowWas Was Now Now
Asset Cost Year Year NoteCabinets Base amp Wall 2000000$ 200 5 Considered Personal PropertyCountertops 1500000$ 150 5 Considered Personal PropertyReception Desk 1000000$ 100 5 Considered Personal PropertyWood Plastics and Composites (Interior Fit-Out) 8000000$ 1250 539 800 39 Mix (1245 amp 1250)
$20000 + $15000 + $10000 + $80000= $125000