New tangible property regulations (Treasury Decision 9636, Guidance Regarding Deduction and Capitalization of Expenditures Related to Tangible Property) were finalized in 2014, after several years of temporary regulations, industry feedback and many revisions. They are the largest single change to the US Tax Code in 30 years. While tax professionals are primarily concerned with compliance—adopting and electing various aspects of the regulations—CSSI plays a consultative role to tax professionals and their clients, creating source documents and assisting in how to adopt/elect into the new regulations. Most property owners still are unaware of how the changes in the tax code will affect them moving forward and looking back.
The new regulations set the standard for whether a purchase or expenditure is to be expensed or capitalized. There are several considerations: various safe harbors (di minimis, small taxpayer, routine maintenance, etc.), improvement standards and a determination of significance in making capitalization vs. expense decisions. As of 2014, everything changed. And while the community of tax professionals are doing a great job catching up, as with any new, all-encompassing law, guidance is needed. There are various income tax benefits in the new regulations that most tax professionals and their clients are not taking advantage of, and some are time sensitive.
Capital-to-Expense “Reversal” Opportunity. Depending upon their situation, many building owners may now reverse previously capitalized costs and expense them in the current year by applying the new regulations to prior years. If you have made various renovation/repair expenditures in the past and at the time it was the proper action to capitalize those dollars, you are allowed to take the new rules backward. If, under the new rules, you could have expensed the item, you are allowed to expense in the current year the undepreciated portion of the cost basis.
Partial Asset Disposition (PAD) allows you to write down the basis of what you disposed of and the costs for the removal and disposal of those items. You can receive a tax deduction in the current year, but it is a use it or lose it opportunity. Fail to capture it in the current tax year, and you lose the ability to write it down. Both capital-to-expense reversals and PADs yield a permanent tax savings at the time of sale by reducing recapture costs.
Building Systems Valuations are engineering-based studies that will identify and place values on building systems and structural components. The regulations give very specific criteria on whether expenditures should be capitalized as an improvement or expensed as a repair. All cost segregation studies provided by CSSI include a building systems valuation report in which the various building systems and major structural components are broken out by current cost and replacement cost. This can be beneficial for your tax professional to make future capitalization/expense decisions. And for properties that cannot benefit from accelerated depreciation with a CSSI cost segregation study, an individual building system report can be issued at reduced cost.
For smaller expenditures, the safe harbors determine the course of handling. For medium to larger expenditures, determination is made by applying RABI (restorations, adaptations, betterments and improvements) standards and the Significance Ratio outlined through many examples in the new regulations. Essentially an expenditure has to be compared to the replacement cost of the building system within the appropriate unit of property. If the ratio is 30 to 35% or less, the expenditure generally can be expensed as insignificant, regardless of dollar amount. Percentages greater than this are determined to be significant and must be capitalized on the depreciation schedule. If a cost segregation study or building systems valuation has not been conducted, the tax professional cannot calculate this ratio and may end up capitalizing an expenditure that otherwise could have been expensed.
Cost Segregation. The method of identifying, classifying and quantifying building components that allows you to accelerate depreciation and generate additional cash flow through income tax deferral is referred to as cost segregation. An engineering-based cost segregation study, with its delineation of component detail, is the basis for allowing you to capture many the tax savings opportunities; and it helps you maintain compliance moving forward with tax regulations.
We encourage you to engage a calculation specialty company such as CSSI to assist your tax professional in bringing you these benefits. With the proper source documents, your tax professional can apply the calculations of a cost study to your tax return, bringing an immediate reduction in income taxes owed. The rules are different from in the past. So a no-cost review of your tax depreciation schedules will bring you good news in one of two ways: either you are in good shape and don’t need the service, or you receive a building analysis quantifying the potential benefit you are missing. A win either way!