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  • 1. Cost Segregation Services Asset Reclassification for Accelerated Depreciation of Business Real Estate Property Presented by: Michael F. Cannon, MA, MBA, AVA President, MCOM Corporation
  • 2. Objectives • Present you with an overview of the significant tax benefits Cost Segregation Studies provide • Describe the new tax law guidance that permits use of these studies • Show you how these studies can benefit your clients 2 MCOM Corporation
  • 3. Overview of the Tax Opportunity • Cost Segregation Studies (CSS) and their Benefits – A CSS is an IRS accepted asset-reclassification process that accelerates tax-depreciation deductions – Real estate is reclassified from 39 yr. or 27.5 yr. depreciable property to shorter-lived (5, 7 and 15 yr.) property for depreciation purposes – Recaptures available depreciation from prior years, producing substantial benefits • IRS Tax Guidance 2004 (IRS Revenue Procedure 2004-11) now allows “Presumptive Approval” of this asset reclassification technique • This procedure is safe and sure. If done following IRS Guidelines and Procedures no restatement of prior tax returns is required 3 MCOM Corporation
  • 4. Cost Segregation Studies Range of Estimated Benefits (Actual Job Results 2005-9) Period Job # 1 Job # 2 Job # 3 Job # 4 Job # 5 Job #6 Depreciable Total 70,000,000 75,000,000 30,500,000 17,000,000 8,200,000 4,300,000 Building 39 55,300,000 64,650,000 25,162,500 13,600,000 6,560,000 3,440,000 Land Improvements 15 5,600,000 3,825,000 1,220,000 1,360,000 656,000 344,000 Furnishings 7 0 0 0 0 0 0 Equipment 5 9,100,000 6,525,000 4,117,500 2,040,000 984,000 516,000 Addl Depreciation 7,975,000 7,090,000 3,790,000 1,797,000 866,000 454,500 Addl Taxes Deferred 3,230,000 2,878,000 1,600,000 727,700 351,000 184,000 Cum NPV@8% 2,425,000 1,850,000 1,080,000 584,000 281,900 147,800 4 MCOM Corporation
  • 5. The Cost Segregation Core Concept The Basis for Component Depreciation • 1250 and 1245 Property Definitions – 1250 Property • Building land and systems, in place to allow and support the functions of the structure as a building • Allows depreciation at 39.5 and 27.5 years – 1245 Property • Building components, land and systems in place to allow and support the functions of the structure as a business • Allows accelerated depreciation at 15, 7 and 5 year terms 5 MCOM Corporation
  • 6. The Major Client Benefits • Allocation of direct costs to shorter asset lives • Accelerated write down of soft/indirect costs • Lowers tax liability and increases cash flow • Recaptures reclassified depreciation back to 1987 in one year “catch-up” • Faster write down of new construction, renovations and/or expansions • No need to amend previously filed tax returns; for entity or for shareholders 6 MCOM Corporation
  • 7. Typical Non Accelerated Case Total Depreciable Building Costs Depreciation Schedule 5 Year Property 7 Year Property 15 Year Property 39 Year Property 0 0 0 100% 7 MCOM Corporation
  • 8. Some Acceleration Done By CPA Firm or Internal Finance Team Total Depreciable Building Costs Depreciation Schedule 5 Year Property 7 Year Property 15 Year Property 39 Year Property 0 2-4% 0 96-98% FF&E 8 MCOM Corporation
  • 9. Systematic Cost Segregation Study Process Professional CSS Team Soft Costs Other Indirect Costs Hard Costs Loan Amortization Expensable Items Total Building Costs Depreciation Schedule 5 Year 7 Year 15 Year 39 Year Expensable Items 8-12% 4-8% 10-15% 65-80% 9 MCOM Corporation
  • 10. Systematic Cost Segregation Study Process Professional CSS Team Soft Costs Other Indirect Costs Hard Costs Loan Amortization Expensable Items Total Building Costs Depreciation Schedule 5 Year 7 Year 15 Year 39 Year Expensable Items 8-12% 4-8% 10-15% 65-80% Personal Property Personal Property Site Work Structural Property  Electrical  FF&E  Site Preparation  Foundations  Plumbing  Security Sys  Concrete  Walls, Roof  HVAC  Accessories  Landscaping  Interior Systems 10
  • 11. Systematic Cost Segregation Study Process Older Buildings Professional CSS Team Soft Costs Other Indirect Costs Hard Costs Loan Amortization Expensable Items Total Building Costs Depreciation Schedule Depreciation Catch Up Prior Yrs 5 Year 7 Year 15 Year 39 Year Expensable Items 8-12% 4-8% 10-15% 65-80% Personal Property Personal Property Site Work Structural Property  Electrical  FF&E  Site Preparation  Foundations  Plumbing  Security Sys  Concrete  Walls, Roof  HVAC  Accessories  Drainage  Interior Systems 11
  • 12. Companies That Benefit the Most • Processing Plants (60-90%) • Heavy Manufacturing (25-70%) • Hotels (20-50%) • Office Building (15-40%) • Retail (15-40%) • Restaurants (15-40%) • Grocery (15-40%) • Light Manufacturing (15-40%) • Nursing Homes (15-30%) • Warehouses (8-12%) 12 MCOM Corporation
  • 13. How Can You Tell If A Client Has Taken Full Advantage of This CSS Benefit? • A look at their depreciation schedules will show; – Total amounts in 5, 7, 15 and 39 year – Types of items accelerated – Existence of report detailing case law support – Systematic approach mandated by IRS • Provide depreciation schedule to reputable Cost Segregation firm for cost/benefit analysis • Client can determine if the cost/benefit is worth it 13 MCOM Corporation
  • 14. Example of Estimated Depreciation Acceleration Original Cost Segregation* Depreciation Estimated Schedule Improvement Depreciation Total $70,000,000 $70,000,000 39 year $68,000,000 15 year $0 $6,000,000 7 year $2,000,000 $0 5 year $0 $9,000,000 Estimated Addl Dep. $0 $8,000,000 Estimated Tax Defer. $0 $2,800,000 *Based on; building type, basis, years in service and item classification 14 MCOM Corporation
  • 15. Some Business Situations Will Not Benefit • Alternative Minimum Tax may reduce immediate benefits to carry forward • Pass thru of benefits has value only to shareholders who can use the deduction • Prompt disposition of property may cause recapture of depreciation if gain is attributed to the accelerated asset, this is generally NOT the case. 15 MCOM Corporation
  • 16. Brief History of How We Got Here • 1962-1997 depreciation taxation rules varied widely between; – Investment Tax Credit case law, ACRS in 1981, Tax Reform Act of 1986 and the Revenue Reform Act of 1989 • 1997 HCA landmark tax court case – became basis for reclassification of assets as per ITC case law – Numerous real estate owners petitioned the tax courts stating that they were required to construct “special use” rooms with special HVAC, electric, etc. systems to run their medical systems and specialty testing instrumentation. • 1999 IRS accepts HCA ruling but vows to “scrutinize” each case • 2004 IRS agrees; – changes in depreciation are “a change in method of accounting”, – allows “presumptive acceptance” of accounting changes, and – eliminates need to amend previous returns • 2005 IRS Guidance (Dec 2004) sets standards on report content, qualifications of preparers, engineering standards, knowledge 16 MCOM Corporation
  • 17. Major Areas of Cost Allocation • 1245 Property – Finish Carpentry – Security and Communications Systems – Electrical – Plumbing – Site Work – HVAC – Specialties and Accessories • Indirect or Soft Costs • Owner Incurred Costs Paid Outside of General Contract 17 MCOM Corporation
  • 18. 1245 Property Finish Carpentry Wall & Floor Coverings Electrical Specialty Finish Woodwork Decorative Millwork 18 MCOM Corporation
  • 19. 1245 Property Security & Communication Systems Interior Electrical for Machinery and Equipment Interior Electrical for Machinery and Equipment Security Lighting 19 MCOM Corporation
  • 20. 1245 Property Sanitary Drainage Plumbing Grease Interceptors Trench Drains Storm Drainage 20 MCOM Corporation
  • 21. 1245 Property Exterior Gas Lines Interior Kitchen Equipment Exterior Decorative Lighting Interior Decorative Site Work Lighting 21 MCOM Corporation
  • 22. 1245 Property Pavement Walkways & Curbing Site Lighting Landscaping HVAC 22 MCOM Corporation
  • 23. 1245 Property HVAC Process Air Conditioning Specialty Equipment Other Specialties & Accessories Duct Work for Kitchen A/C for Computer Process 23 MCOM Corporation
  • 24. Cost Segregation Process Is Detailed and Exacting: Requires Specialized Expertise • Taxation Planning and Procedures Specifically for Cost Segregation Studies • In Depth Engineering Expertise • Detailed Project Management Expertise 24 MCOM Corporation
  • 25. Taxation Expertise • New Depreciation Rules and Regulations • Specialized Tax Case Law verdicts from; – 1970’s Investment Tax Credit case law – Tax Reform Act of 1986 and Revenue Reform Act of 1989 – HCA Case 1997 – IRS HCA tax court ruling 1999 – 2004 IRS new rulings and guidance • Body of case law, recent verdicts and pending cases Tax Law Expertise Engineering Team Project Management 25 MCOM Corporation
  • 26. Engineering Expertise • Cost segregation engineers, licensed and experienced in the field, with deep knowledge in – Site, costing, materials, estimating expertise – RS Means, Marshall & Swift data mining • Wide experience in all cost segregation aspects – Latest knowledge in real estate tax innovation and CSS study development – Site visit documentation process for all reclassification activities – Manage all aspects of component analysis, verification and take offs as well as building cost reconstruction where data is not available Tax Law Expertise Engineering Team Project Management 26 MCOM Corporation
  • 27. Project Management Expertise • Project managers must be experienced in – Direction of program components and scheduling of multi-team efforts – Control systems to deliver projects on time and within approved budget – Coordination of key data with client/CPA firms – Key supplier relationships for essential information gathering; GC, Subcontractors, suppliers, plans, AIA, Change Orders, Invoices Tax Law Expertise Engineering Team Project Management 27 MCOM Corporation
  • 28. How We Would Work With Your Clients • Adapt to whatever form you feel is best for your client – Independent supplier of the service – Associated company to your services – As a part of your internal client service • Our process would follow you and your client preferences • An “average” process would be as follows; – Initial presentation of service to client – Client provides depreciation schedule for review – We present potential benefit and study costs to client for review – Client gives us additional information on building property to begin study – Client signs engagement letter – We begin the project 28 * Client Responsibility
  • 29. Essential Steps In the Work Process • Acquire and organize all construction information • Assure that “all in” numbers tie to depreciation schedule totals* • Assign work teams and establish timetables – engineering and construction experts to hard cost analysis – financial team to all indirect and soft cost analysis • Conduct site visits and obtain photographic documentation • Allocate the building costs to their appropriate depreciable tax lives • Write and assemble report components; – project methodology and background narratives – engineering breakdown and cost estimates – summary of the new real and personal property by the appropriate tax lives – documentation (IRS Code, Treasury Regulations, court cases and revenue rulings) as it applies to use of the real estate and your specific industry • Report serves as stand alone substantiation to support conclusions • Present completed report and IRS Form 3115 to your team • Team usually made up of 6 to 8 experts 29 * Client Responsibility
  • 30. Materials Available For Your Review • Examples of Completed Studies • Information Guide To Initiate Work • Depreciation Acceleration Estimates from Existing Depreciation Schedules 30 MCOM Corporation
  • 31. Thank You!