atg Travis Mlodzik CCSP Agenda Cost Segregation Milestones Chapter Dive Chapter 1 Introduction Chapter 2 Legal Framework Chapter 3 Cost Segregation Approaches Chapter 4 Principal Elements of Cost ID: 774832
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Slide1
Audit techniques guide (atg)
Travis Mlodzik, CCSP
Slide2Agenda
Cost Segregation Milestones
Chapter Dive
Chapter 1 – Introduction
Chapter 2 – Legal Framework
Chapter 3 – Cost Segregation Approaches
Chapter 4 – Principal Elements of Cost
Seg
Study & Report
Chapter 5 – Review & Examination of Cost
Seg
Study
Chapter 6 – Special Topics
Chapter 7 – Industry Specific Guidance
Chapter 8 – Issue Specific Guidance
Items Outdated – last revision in 2016
ASCSP & the ATG
Questions?
Slide3Cost Segregation milestones
Hospital Corporation of America v. Commissioner (HCA)
Landmark case for cost segregation
1999 – Treasury
Regs
§1.446-1
Cost
seg
study considered a change in accounting method
1999 – AOD CC-1999-008
IRS acquiesced to validity of method approved in HCA case
pre-1981 ITC tests remained applicable for determining tangible personal property under ACRS & MACRS
Cost Segregation is acceptable
2004 – Audit Techniques Guide (ATG) Released
Continually monitored & updated with new law
Latest revision in 2016
Slide4Chapter 1 - introduction
Can the ATG be cited as authority?
No, developed to assist IRS examiners when reviewing/examining cost
seg
studies
Purpose of the Cost
Seg
ATG
Why cost
seg
studies are performed for Federal income tax
How they are prepared
What to look for in review & examination
When issues need further examination
Reason for cost studies
Allocate building costs to §1250 & §1245 property
§1250 – real property (39-year or 27.5- year)
§1245 – tangible personal property (5 or 7 years)
Slide5Chapter 2 – Legal Framework
History of Depreciation
Present income tax system began in 1913
For 20 years, taxpayers had freedom to determine depreciation allowances
Bulletin “F” – first issued in 1920; defined depreciation
1931 – revised and released first schedule of suggested lives
1942 – revised again & provided useful life guide for various types of property based on taxpayers business or industry
Also described two procedures to compute depreciation
Composite Method: rates of depreciation corresponding to useful lives ranging from 28.5 to 66.7 years
Component Method: depreciate building separate from equipment; structures range from 50 to 75 years while equipment ranges from 5 to 25 years
Accelerated Cost Recovery System (ACRS)
1981 – simplify depreciation rules & stimulate the economy
Allow greater deductions over shorter periods of time
Prohibited Component Depreciation
Applicable to property placed-in-service between 1981 & 1986
Slide6Chapter 2 – Legal Framework cont.
Modified Accelerated Cost Recovery System (MACRS)
Current depreciation system
General Depreciation System (GDS) & Alternative Depreciation System (ADS)
Cost recovery now based on applicable depreciation method, recovery period & convention
Class lives are set forth in Rev. Proc. 87-56
Asset category (00.11 through 00.4) versus Activity category (01.1 through 80.0)
Incentives for cost segregation & cost recovery
Bonus Depreciation (§168(k))
Election to expense certain business assets (§179)
QLIP (§168(e)(6)), QRP (§168(e)(7)) & QRIP(§168(e)(8))
Congress enacted the provisions of §1250 & §1245
Investment Tax Credit - §48 (Repealed in 1986)
Inherently Permanent Test (
Whiteco
Industries, Inc. v. Commissioner)
HCA
Amerisouth
XXXII Ltd. v. Commissioner
Slide7Chapter 3 – Cost segregation approaches
Detailed Engineering Approach from Actual Cost Records
Construction
Detailed Engineering Cost Estimate Approach
Acquisitions
Survey or Letter Approach
Alternate method for new construction
Residual Estimation Approach
Abbreviated approach by just pulling out the §1245 property
Sampling or Modeling Approach
Nearly identical buildings
“Rule of Thumb” Approach
“Industry Averages”
What approach is required by the IRS?
None, but some are more accurate than others
Slide8Chapter 4 – elements of a quality study & Report
Elements of a Quality Cost Segregation Study
Preparation by an individual with expertise & experience
Detailed description of methodology
Use of appropriate documentation
Interviews conducted with appropriate parties
Use of a common nomenclature
Use of a common numbering system
Explanation of legal analysis
Determination of unit costs & engineering take-offs
Organization of assets into lists or groups
Reconciliation of total allocated costs to total actual costs
Explanation of the treatment of indirect costs
Identification & listing of § property
Consideration of related aspects
Slide9Chapter 4 – elements of a quality study & Report
Elements of a Quality Cost Segregation Report
Summary letter/Executive summary
Narrative report
Schedule of assets
Schedule of direct & indirect costs
Schedule of property units & costs
Engineering procedures
Statement of assumptions & limiting conditions
Certificate
Exhibits
Are these elements required in a Cost
Seg
Study?
No, but a quality study & report will expedite the exam process.
Slide10Chapter 5 – review & examination of a css
Steps to examining a study
Review for risk analysis purposes
Verify the cost basis & reconcile the depreciation to the tax return
Conduct initial risk analysis to evaluate audit potential
Examination
Review for examination purposes
Interview the preparer
Inspect the property
Review and verify the classes of property
Research the Tax Law
Cost Analysis
Summarize the findings & discuss the challenged assets with taxpayer
Prepare notice of proposed adjustments
Other considerations
Perform cost analysis; New construction or Acquired; Review sampling; Consider §263A; Consider change in Accounting Method (Form 3115)
Slide11Chapter 6 – Special Topics
Chapter 6.1 – Uniform Capitalization
UNICAP – capitalize all direct costs & certain indirect costs allocable to real and tangible personal property produced by the taxpayer - §263A
Capitalization of Costs under §263A(a)
Indirect Costs
Capitalization of Interest under §263A(f)
Chapter 6.2 – Change in Accounting Method
PECO Food Case
Tangible Regulations §1.263(a)
Revenue Procedures involving Method Changes (Form 3115)
Non-automatic – Rev. Proc. 97-27, 1997-1 C.B. 680
Automatic – Rev. Proc. 2011-14, 2011-1 C.B. 330
Slide12Chapter 6 – special topics
Chapter 6.3 – Depreciation Overview
MACRS
IRC §167 provides a depreciation allowance for wear & tear of property used in a trade or business or held for production of income
Since 1986, generally determined under §168 Modified Cost Recovery System
Two methods: General Depreciation System (GDS) & Alternative Depreciation System (ADS)
Depreciation Periods & Conventions
GDS has ten property classes based on recovery periods
3, 5, 7, 10, 15, 20, 25, 27.5, 39 or 50 years
Methods include: 200% declining balance; 150% declining balance; straight line
ADS must be used for the following property
Property used 50 percent or less for business
Tangible property used predominantly outside the US
Tax-exempt use property
Tax-exempt bond financed property
Certain other finite categories of property that are not common
Slide13Chapter 6 – special topics
Depreciation Periods & Conventions Cont.
Conventions
Half-year: applies to property other than residential rental property, nonresidential real property, & railroad grading and tunnel bores
Mid-month: applies to residential rental property, nonresidential real property, & railroad grading and tunnel bores
Mid-quarter: applies to property (other than residential rental, nonresidential real property & railroad grading and tunnel bores) if more than 40% of aggregate basis is placed in service during the last three months of the tax year
Recovery Periods
Rev. Proc. 87-56
Asset Classes 00.11 to 00.4 – consist specific assets used in all business activities
Asset Classes 01.1 to 80.0 – consist of assets used in specific business activities
Slide14Chapter 6 – special topics
Chapter 6.4 – Relevant Court Cases
AmeriSouthXXXII
: 2012 – Site Prep; Site Electric; Special HVAC; Special Plumbing; Special Electrical; Millwork
PPL Corporation: 2010 – Street Lights
L.L. Bean, Inc: 1998 – Electrical System; Fire Protection System; Concrete Slab Floor
SuperValu
Inc: 1997 – Refrigeration System
HCA: 1997 – Vinyl Floor Covering; Patient Corridor Handrails; Carpeting; Acoustical Ceilings
Boddie
-Noelle Enterprises, Inc: 1996 – Kitchen HVAC; Plumbing to Equipment; Electrical to Equipment
La Petite Academy: 1995 – Fencing – Playground; Exterior Façade Lighting; Kitchen Grease Trap; Dumpster Enclosure
Morrison, Inc: 1990 – Kitchen Hand Sinks; Eliason Doors; Customer Line Screen; Kitchen Grease Trap
Slide15Chapter 6 – special topics
Chapter 6.4 – Relevant Court Cases
Metro National Corp.: 1987 – Partitions; False Ceilings w/Lighting; Exterior Security Lighting; Cabinets & Hardware
Piggly Wiggly Southern, Inc.: 1986 – HVAC Units
Illinois Cereal Mills, Inc: 1986 – Electrical Distribution System
Shoney’s South, Inc.: 1984 – Chandeliers & Lanterns
A.C. Monk & Co: 1982 – Louvered Wall; Electrical Distribution System; High Bay Roof; Storage Sheds
Scott Paper Co.: 1980 – Electrical Distribution System
Whiteco
Industries, Inc.: 1975 – Outdoor Signs (Billboards)
Slide16Chapter 6 – special topics
Chapter 6.5 – Inherently Permanent
Inherently Permanent under §168 –
Whiteco
Inherently Permanent under §263A – UNICAP
Chapter 6.6 – Construction Process
Cost Segregation Studies are typically completed using information developed for the construction process
Concept
Contracts & Bid Documents
Bidding
Construction Field Work
Construction Payments
Completion
Slide17Chapter 6 – special topics
Chapter 6.7 – Information Document Requests
Appropriate documentation is needed to support the conclusions in a cost segregation study
Participants & respective roles
Specific properties subject to the study
Property blueprints & drawings
Obtain a copy of the CSS
Secure computations
Ask specific questions regarding segregated property
Request for specific items & amounts in question
Chapter 6.8 – Bonus Depreciation Considerations
Eligible Property
Qualified Leasehold Improvement Property
Acquisition Requirements & Placed in Service Dates
Method of Accounting Issues related to Bonus Depreciation
Election out of Bonus
Slide18Chapter 7 – Industry specific guidance
Chapter 7.1 – Casinos
Multiple Asset Classes for property
Recreation: Asset Class 79.0
Distributive Trades & Services: Asset Class 57.0
Electrical:
Main Office Areas; “Back of House”; Hotel Rooms: §1250 - 39-years
Specifically associated w/equipment in Casino area: §1245 - 7-years (79.0)
Specifically associated w/equipment not in Casino/Theater: §1245 - 5-years (57.0)
Chapter 7.2 – Restaurants
Mainly uses Asset Class 57.0
Décor Accessories: §1245 - 5-years
Non-Structural Theme Elements: §1245 - 5-years
Restaurant Furniture: §1245 - 5-years (other than office furniture); 7-years (office furniture) (00.11 – Office FF&E)
Slide19Chapter 7 – Industry specific guidance
Chapter 7.3 – Retail Industries
Mainly uses Asset Class 57.0
Kiosks: §1245 - 5-years
Parking Structures: §1250 – 39-years
Security Systems: §1250 – 39-years (General Building Security); §1245 – 5-years (Primary purpose to minimize loss due to theft)
Chapter 7.4 – Pharmaceutical & Biotechnology
Recovery period is going to depend on use of the property
Activity Classes 01.1 to 80.0 or “Certain Property for which Recovery Periods Assigned”
Land Improvements
Some activity classes include Land Improvements which could change §1245 recovery
Many assets are Personal Property with no Class Life
Default to 7-year recovery period
Slide20Chapter 7 – Industry specific guidance
Chapter 7.5 – Auto Dealership Industry
Primarily Asset Class 57.0 (5-year §1245)
Bollards & Guardrails: §1250, Land Improvements, or §1245
Floor Pits & Trenches: §1250 – 39-years
Equipment: §1245 – 5-years
Security Systems: §1250 or §1245
Chapter 7.6 – Auto Manufacturing
Asset Class 37.11 – Manufacture of Motor Vehicles (7-year §1245)
Catwalks & Mezzanines: §1250 (building); §1245 (7-years) – only provide access to process machinery or equipment
Electrical Distribution
Gate House: §1250 – 39-years
Guard Shack/Booth: §1245 – 7-years
Loading Dock: §1250 – 39-years
Slide21Chapter 8.1 – electrical distribution systems
Definitions & Illustration
Connected Load: actual power required by a specific circuit to operate end-use equipment
Demand Load: factored load of entire electrical system design
Functional Allocation Approach: how a building’s EDS is allocated proportionally by demand load (Scott Paper v. Commissioner, 74 T.C. 137
Primary EDS: electrical equipment that receives power from outside the building to the MDPs
Secondary EDS: equipment that takes power from MDPs to panels
Branch Circuits: connections between panels and end-use device
Legal
Backround
Scott Paper: allowed allocation based on design “load”
A.C. Monk: rejected the functional allocation approach (more general uses)
Boddie-Noell: no portion of EDS is allocable to §1245
Illinois Cereal Mills: affirmed the functional allocation approach
Slide22Chapter 8.1 – electrical distribution systems
Functional Allocation – Illustration
Step 1: determine whether the components of the EDS are inherently permanent structures
Step 2: determine if the EDS serves the operation & maintenance of a building or provides power to tangible personal property
Step 3: allocate the costs proportionally based on electrical demand load of various items served
Must analyze the buildings electrical design plans
Step 4: total the electrical demand load & determine the allocation of the EDS
Slide23Chapter 8.2 – stand-alone open-air parking structures
Description of Stand-alone open-air parking structures
Parties’ Positions
Taxpayers: if not connected to the building treated as land improvements; if connected to the building agree that they have 39-year recovery period
IRS: fall within the definition of a building as they satisfy the appearance test
Function Test – requires structure to provide shelter or housing, provide working, office, parking, display, or sales space
Appearance Test: requires structure enclosing a space within its walls and usually covered by a roof
Penalty
20% accuracy-related penalty that applies to any substantial understatement of income tax
20% accuracy-related penalty that applies to the portion of any underpayment of tax attributable to negligence or disregard of rules or regulations
Slide24Outdated Items
Bonus Depreciation
Tax Cuts & Jobs Act of 2017
100% bonus
Acquired properties now eligible
Qualified Improvement Property
Need technical correction to 15-year
Qualified Leasehold Improvements
Qualified Restaurant Property
Qualified Retail Improvements
Slide25ASCSP & the atg
Minimum Quality Standards Manual (MQS)
Developed by the ASCSP Technical Standards Committee
For use within ASCSP Membership
Modeled after the ATG
Outlines the principal elements of a cost segregation report
Outlines the engineering approaches
Lists key Revenue Procedures
Lists relevant case law & revenue rulings
Additional requirements to stamp or sign report with ASCSP designation
Slide26QUESTIONS?
Slide27THANK YOU
Travis Mlodzik, CCSP
Senior Manager, National Tax Office
tmlodzik@eidebailly.com
612.253.6627