Keeping up with the ever-changing landscape of tax regulations around commercial real estate can be a full-time occupation. Case in point: On Jan. 24, the Internal Revenue Service issued further guidance on tangible property regulations. The clarification, called Rev. Proc. 2014-16, creates an opportunity for taxpayers to take advantage of regulations that pertain to capitalization […]
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Keeping up with the ever-changing landscape of tax regulations around commercial real estate can be a full-time occupation. Case in point: On Jan. 24, the Internal Revenue Service issued further guidance on tangible property regulations. The clarification, called Rev. Proc. 2014-16, creates an opportunity for taxpayers to take advantage of regulations that pertain to capitalization and repair treatment for certain assets.
According to a summary by PWC, all taxpayers must comply with the final repair regulations beginning with their first tax year that begins on or after Jan. 1, 2014. However, taxpayers have several implementation options with respect to tax years beginning on or after Jan. 1, 2012, and on or before Jan.1, 2014. Taxpayers may continue with their existing methods of accounting; adopt the 2011 temporary IRS regulations; or adopt the final regulations early. These regulations apply to materials and supplies; repairs; capital expenditures; amounts paid to acquire, produce or improve tangible property; and capitalized costs for real property acquired through foreclosure.
The correct option could save a commercial real estate investor several thousands of dollars on his or her federal tax bill. Rev. Proc. 2014-16 is welcome news, as there has been a great deal of conjecture about the mechanism by which taxpayers and their advisers could properly account for these expenditures.
Tapping expertise
To better understand the tax implications of the new regulations, a commercial property investor might want to consider consulting with a cost segregation firm.
So what exactly is cost segregation? It is a widely accepted tax planning strategy utilized by commercial real estate owners and tenants to accelerate depreciation deductions, defer tax and improve cash flow. A quality cost segregation study is based on a detailed engineering analysis, which involves a thorough review of information such as cost data, building plans and lease agreements, as well as an on-site inspection of the property conducted by a qualified engineer. As an investor or property owner, you may want to find out if your CPA or trusted adviser is already utilizing a cost segregation strategy on your behalf. If you are seeking a firm on your own, you should perform due diligence and check with the American Society of Cost Segregation Professionals for a reputable professional. In 2009, the ASCSP introduced the first set of industry standards and professional certifications.
Because laws are in a constant state of flux, new services and strategies are always in development. For example, a recent popular study looks at repair vs. capitalization and enables taxpayers to take advantage of recently promulgated IRS repair regulations regarding the deduction and capitalization of expenses relating to the acquisition, renovation or improvement of real estate. Although this concept is simple, the implementation and development of supporting documentation requires a high level of tax expertise and construction engineering experience. It also requires that an enhanced cost segregation study be utilized as a baseline to determine “units of property,” as defined by the IRS. Depending on whether incoming assets are “betterments” will determine a taxpayer's eligibility to expense (as opposed to capitalize) some big-ticket items. Based on certain criteria, examples of deductible repair costs include replacing HVAC, windows, doors, lighting, as well as roof repairs and even replacing sidewalks and parking lots.
A cost segregation study is typically performed the year the property is placed in service by the current owner. It is generally most beneficial to maximize depreciation deductions from year one, but a cost segregation study can be performed on a property placed in service where a tax return has already been filed. This type of study is called a look-back study and no amended tax returns are required. The catch-up depreciation is taken as an additional deduction with the current tax return.
Greg Bryant, managing partner at Bedford Cost Segregation LLC in Bedford, N.H., can be reached at gbryant@bedfordteam.com. He will be presenting on this topic at a Maine Real Estate and Development Association seminar on Feb. 12 in Bangor. For more information, go to mereda.org.