Now is the Time to "Tune-Up" your Depreciation Schedule

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Depreciation can be compared to the gas mileage you get from your car. Just as you would do everything you can to increase your gas mileage, you should do every thing you can to increase your depreciation expense.

Whether or not you have already commissioned a Cost Segregation Study, or taken advantage of the 179D Federal Energy Tax Deduction, now is the time to schedule a full-blown ”Tune-Up” of your depreciation schedule.

The IRS opened a window in January that gives commercial property owners a chance to increase depreciation expense and cash flow while reducing taxes. This is possible through Cost Segregation Studies, “ghost” Asset Retirement Studies and the “179D” tax deductions available through the Energy Policy Act of 2005. You can also write-off the “ghost” assets created when those new “179D” assets are installed. The window closes next year.

All investment property owners will fit into one of these four groups.

If you have not had a Cost Segregation Study done, and have not taken advantage of the “179D” tax deductions, you should secure:

  1. A cost-benefit analysis of having cost segregation applied to your property.
  2. An analysis of the dollar benefit associated with the removal of “Ghost” assets from your depreciation schedule.
  3. An analysis of the potential for “179D” tax deductions provided by an independent, unrelated party utilizing DOE and IRS approved energy modeling software.
  4. An estimate of the write-offs available from the assets replaced by the “179D” assets.
  5. Each of these should project your bottom-line benefit, if implemented.

If you have had a Cost Segregation Study done, but have not taken advantage of the “179D” tax deductions, you should secure:

  1. A review of your existing Cost Segregation Study in light of a 2011 Tax Court decision. The court not only disqualified a study that did not meet IRS criteria, it more importantly concluded that even after the statute is closed on the year that the study was done, if that faulty study is used to calculate depreciation at any time during your ownership of the property, you are vulnerable.
  2. A cost-benefit analysis of the re-application of cost segregation to your property, if indicated.
  3. An estimate of the dollar benefit associated with the removal of “Ghost” assets from your depreciation schedule.
  4. An analysis of the potential for “179D” tax deductions provided by an independent, unrelated party utilizing DOE and IRS approved energy modeling software.
  5. An estimate of the write-offs available from the assets replaced by the “179D” assets.
  6. Each of these should project your bottom-line benefit, if implemented.

If you have not had a Cost Segregation Study done, and have taken advantage of the “179D” tax deductions, you should secure:

  1. A cost-benefit analysis of having cost segregation applied to your property.
  2. An analysis of the estimated dollar benefit associated with the removal of “Ghost” assets from your depreciation schedule.
  3. An estimate of the write-offs available from the assets replaced by the “179D” assets.
  4. Each of these should project your bottom-line benefit, if implemented.

If you have had a Cost Segregation Study done, and have taken advantage of the “179D” tax deductions, you should secure:

  1. A review of your existing Cost Segregation Study in light of a 2011 Tax Court decision. The court not only disqualified a study that did not meet IRS criteria, it more importantly concluded that even after the statute is closed on the year that the study was done, if that faulty study is used to calculate depreciation, at any time during your ownership of the property, you are vulnerable.
  2. A cost-benefit analysis of the re-application of cost segregation to your property, if indicated.
  3. An analysis of the estimated dollar benefit associated with the removal of “Ghost” assets from your depreciation schedule.
  4. An estimate of the write-offs available from the assets replaced by the “179D” assets.
  5. Each of these should project your bottom-line benefit, if implemented.

After you have determined which of the above groups you are in, you should begin to evaluate vendors. Ask each potential cost segregation vendor to include a sample of a completed study with their proposal. When you compare proposals, your most important consideration should be the amount of line item detail provided in their final report.

Line items in your Cost Segregation Study become line items on your depreciation schedule.

The following example shows how “ghost” assets are created and how they can be removed from a property that has not benefitted from cost segregation.

On June 1, 2009, Building Owner B purchased and is depreciating a $25,000,000 property that was constructed in 2000. On March 15, 2012, Building Owner B replaced four of the twelve HVAC rooftop units. Without the benefit of having a Cost Segregation Study, these assets were not separately stated and the building was accounted for as a single asset (single line item) with a cost of $25,000,000. The property was depreciated as non-residential real property and used the straight-line method of depreciation with a 39-year recovery period. Because Building Owner B cannot identify the cost of the components of the property from its records, it hires a cost segregation engineering firm to determine the costs of the HVAC units. It is determined that at the time of purchase the HVAC units were each worth $267,000. Using the straight-line 39-year depreciation method and mid-month convention, Building Owner B was able to recognize a loss in the current year of $991,551.

Similarly, an inadequate Cost Segregation Study makes it impossible to write-off the undepreciated balance of those four rooftop air conditioning units. If your Cost Segregation Study showed just one $4,500,000 line item, covering all of the HVAC components throughout the property, that is the only detail that will appear on your depreciation schedule. Again, that is not enough detail to write-off the undepreciated balance of $247,888 for each of the four units replaced.

To insure that your study will not only satisfy the IRS, but will also maximize your immediate dollar benefit while preventing the future accumulation of “Ghost” assets, you should insure that your completed Cost Segregation Study contains as many line items as possible.

While you have until next year to “Tune-Up” your depreciation schedule, your tax savings can begin with your next quarterly tax filing after your depreciation schedule is “Tuned-Up.”

THE AUTHOR: After more than 20 years in management consulting, Michael Donohue now represents M&E Cost Segregation. He brings the benefits of cost segregation directly to owners of investment properties. He also speaks to real estate professionals, accountants, financial advisors, bankers and others about how their clients' properties could also benefit. He can be reached at MDonohue@costsegleader.com.

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