Philip Mann, MS
Consultants, LLC

The Federal Tangible Property Regulations (TPR) were recently enhanced, handing taxpayers a greater number of ways to increase their income tax deductions through repair and maintenance expenses and they continue the ability to write-off structural components of buildings. In the same way, the “Protecting Americans from Tax Hikes (PATH) Act of 2015” brings taxpayers relief through a number of now-permanent deductions. Perhaps lesser known than those provisions, but just as powerful, Cost Segregation Studies (CSS) serve to maximize tax savings for organizations that own real property. Using all three of these in combination is a potent equation for taxpayers.

Tangible Property Regulations updates

Jeff Hiatt, MS Consultants, LLC

To begin, the IRS has increased the de minimis safe harbor election threshold from $500 to $2,500 per unit per invoice to be expensed, instead of capitalized, for taxpayers without applicable financial statements. This safe harbor is an attempt to decrease the recordkeeping and compliance burden on small businesses and individual taxpayers, who can automatically expense these amounts, provided they have the necessary documentation to substantiate their claims. Larger thresholds are available for taxpayers with applicable financial statements, provided all requirements are met.

Additionally, Revenue Procedure 2015-56 aimed to reduce the disputes that arise regarding the deductibility or capitalization of remodel and refresh costs incurred by companies in the retail and restaurant industries. This Rev. Proc. provides a safe harbor method of accounting for applicable taxpayers and assists in determining whether or not expenses paid or incurred in the remodel/refresh of a qualified building meet the requirements.  There are many exceptions and provisions within this Rev. Proc.

PATH Act

In mid-December, Congress passed a tax-extender package, and some of its provisions became permanent. This is very good news for many taxpayers. Some of the provisions of the tax extenders are:

• Enhanced Section 179 deductions. Taxpayers may now deduct up to $500,000 of the cost of fixed asset additions, with a phase-out beginning at $2 million of additions. This includes qualified leasehold improvements (QLI), qualified retail improvement property (QRIP) and qualified restaurant property (QRP) at the $500,000 limit as well.

• Qualified leasehold, retail and restaurant improvements. The 15-year straight line depreciable lives for QLI, QRP, and QRIP are now permanent.

• Bonus depreciation. Now extended through 2019, bonus depreciation allows for the immediate expensing of fixed asset additions. The bonus percentages are 50% for 2015 through 2017, 40% for 2018 and 30% for 2019. Bonus applies to most new property with a recovery period of 20 years or less.

• Energy-efficient commercial property. The Section 179D energy deduction is now extended through 2016.  179D is available to commercial building owners, tenants, architects, and more.  The deduction is based on the square footage of the energy efficient property.

• Energy-efficient homes. Section 45L, which provides a $2,000 credit for manufacturing energy-efficient homes, is extended through 2016.

Cost Segregation Studies

A cost segregation study allocates various classes of assets to their proper depreciable lives that are required by the IRS. Without a cost segregation study, all assets in a commercial building are written off over 39 years, or in the case of residential property, over 27.5 years. A cost segregation study allocates assets to various depreciable lives generally ranging from 5 to 39 years. This allows a taxpayer to take increased depreciation over a shorter number of years for a portion of the building costs. The allocation of assets may also unlock bonus depreciation for property with a recovery period of 20 years or less. The increased depreciation allows for larger tax deductions and less income tax paid, thereby increasing cash flow in the early years of a project. And of course, most real estate owners want the cash to acquire another property.

Another benefit of a cost segregation study is the cost breakout it provides for structural components of a building that are required to be depreciated over 39 or 27.5 years. Since a cost segregation study has hundreds or thousands of line items, when assets are replaced a taxpayer can write off the net tax value of the replaced asset in accordance with the Tangible Property Regulations.

In many instances, when a taxpayer acquires a property the building is input on the deprecation schedule in one lump sum amount and depreciates over 39 or 27.5 years. This creates a dilemma in future years when new windows need to be installed and the taxpayer is unable to identify the cost of the original windows. The great news is that the IRS will allow you to go back in time and perform a cost segregation study to identify the original cost of the windows so they can be written-off, most likely resulting in a deductible loss on the taxpayer’s income tax returns. Even greater news is that the IRS will allow a taxpayer to go back in time and put the assets in the correct asset life, typically resulting in additional depreciation deductions in the year a taxpayer decides to have the cost segregation study performed.

This awesome trifecta – Tangible Property Regulations, PATH Act and cost segregation studies – each of which offers attractive income tax advantages on its own, together will enable taxpayers to realize significant income tax benefits for 2015 and beyond.

Jeffrey Hiatt is director of new business development and Philip Mann is managing director at MS Consultants, LLC, Williamsville, N.Y.