Publication 946 – What the publication doesn’t tell you

Overall, this is a handy guide that covers numerous depreciation related topics as follows: 

1. Overview of Depreciation

2. Electing the Section 179 Deduction

3. Claiming the Special Depreciation Allowance

4. Figuring Depreciation under MACRS

5. Additional Rules for Listed Property

6. How To Get Tax Help

As cost segregation professionals, Tax Advisors’ main interest in Publication 946 is as a quick reference guide for the calculation of depreciation using either the General Depreciation System (GDS) or the Alternative Depreciation System (ADS) to depreciate property under the Modified Accelerated Cost Recovery System (MACRS). 

The publication states, “The Modified Accelerated Cost Recovery System” (MACRS) is used to recover the basis of most business and investment property placed in service after 1986.  MACRS consists of two depreciation systems, the General Depreciation System (GDS) and the Alternative Depreciation System (ADS). Generally these systems provide different methods and recovery periods to use in figuring depreciation deductions.”

The publication further states, “You generally must use GDS unless you are specifically required by law to use ADS or you elect to use ADS.”  Most clients we work with use GDS because it results in greater accelerated depreciation and shorter recovery periods for depreciable costs.

Wow – those three paragraphs are a mouth full!  

The guide explains general asset accounts and how to group property:

- Asset class, if any

- Recovery period

- Depreciation method

- Convention

The guide also briefly explains the placed in service date and the cost basis for depreciation.

Appendix A is the MACRS Percentage Table Guide, in which, the user will find the MACRS Percentage Table Guide for both the General Depreciation System (GDS) and the Alternative Depreciation System (ADS).  This guide explains what depreciation method, recovery period, convention, asset class and what table to find the actual depreciation percentage to utilize.

Appendix B contains the Table of Class Lives and Recovery Periods, in which, the user will find a brief description of each asset class to assist in determining the current MACRS class life and the associated recovery period.

In comparing the 2004 version to the 2009 version of Publication 946, we noted an increase in size from 112 to 120 pages, but we don’t think this necessarily improved its usability much, for the lay person.

Aside from navigating the complex system of requirements for correctly identifying the correct asset class, depreciation method, recovery period etc.; a taxpayer who owns real estate is left with perhaps some large questions unanswered:

What is section 1245 and 1250 property?  How can I tell the difference? Why does it matter?

Publication 946 identifies section 1245 property as, “Property that is or has been subject to an allowance for depreciation or amortization.  Section 1245 property includes personal property, single purpose agricultural and horticultural structures . . . “

Publication 946 identifies section 1250 property as, “Real property (other than section 1245 property) which is or has been subject to an allowance for deprecation.”

Unfortunately, these definitions of section 1245 and 1250 property do not provide practical classification criteria.  This is troublesome for most users because identifying and quantifying shorter-lived 1245 (personal property) and 15-year section 1250 property is essential in maximizing the return on real estate investments.  So without clear guidance from Publication 946,  it is difficult for a property owner to get the most value out of their property (another blog item at our website addresses critically important points related to section 1245 and 1250 property).    

These questions and brief explanation strike at the core of why taxpayers who own real estate should use knowledgeable accountants in conjunction with cost segregation professionals to get their tax help. 

So how should a taxpayer get tax help? Here’s our advice:

1) Make sure that you select a knowledgeable tax accountant to perform your tax work.  A good tax accountant will help assure that the depreciation is handled correctly. 

2) Obtain the services of a cost segregation professional.  Only an expert cost segregation professional will have the necessary skill set to be able to understand the many nuances that distinguish shorter lived assets (section 1245) and 15-year section 1250 real property from longer lived 1250 real property.  A cost segregation professional will also be able to identify and quantify the associated cost basis for these assets. 

Can a good cost segregation professional help figure out if you really can benefit from their help? Yes, and usually for free.

Do cost segregation professionals cost money to employ? Yes, but the return on their services for the due diligence, IRS audit trail and financial benefit they give a property owner is normally very high compared to their cost.  (It’s typically a high return on investment.)  

 Aaron Taylor

Tax Advisors pllc

http://www.costsegteam.com

It’s Not Too Late!

Have you Purchased or Constructed Property in the Last 10 Years?
And Not Had a Professional Cost Segregation Done?

It’s Not Too Late!

We can do the cost segregation, now, that you could have had done when you bought or built the property. These cost segregations are known as retrospective or look-back cost segs and can be used as the basis for recalculating depreciation deductions for prior years.

These look-back cost segs provide additional deductions (called section 481 adjustments) that save tax dollars for many taxpayers. In fact, the tax benefits of a retrospective cost seg often are more significant than the cost seg of new construction or the purchase of an existing property.
We’ve helped many clients get significant tax savings from these look-back cost segs. Ifyou like, we’ll consult with your tax accountant to advise you if a look back cost seg will save you money.
In general, amounts re-classified to shorter tax lives in a look-back cost seg will qualify for an automatic accounting method change with the IRS. Some of the accounting details: Your accountant may already be aware of the reporting process for this change: the correct procedure for a taxpayer to change its accounting method is the timely filing of Form 3115, Request for Change in Accounting Method. Rev. Proc. 2004-11 modifies Rev. Proc. 2002-9 and other revenue procedures to conform with § 1.446-1T(e)(2)(ii)(d) of the temporary Income Tax Regulations.

Kent Osborne

Tax Advisors pllc

http://www.costsegteam.com

Reasons For Having a Professional Cost Segregation

Rather Than Trying to Do One In-House

In the course of our work at Tax Advisors, I see attempts at cost segregations done in-house by clients. These invariably contain material errors. One of the most common errors I see, when reviewing these in-house attempts at cost segregation, is the classification as 5 or 7 year of ALL tenant improvement items that were purchased separately from the building onstruction or renovation. 

Take the renovation of a hotel, for example. In these in-house cost seg attempts, I often see all the light fixtures and plumbing fixtures, including even toilets and lavatories, classified as 5 year, apparently because they were purchased directly by the hotel company and given to the building contractor to install.

The logic apparently is: we purchased these separately as fixtures, therefore they are personal property.

That will not fly with the IRS, and will be disallowed if there is an audit.

The law is that whether light fixtures are 39-year or 5-year in a hotel depends on whether the light fixture is decorative and provides illumination above that required for general building use. And toilets and lavatories are never personal property.

In the same cost segs that make the above mistake, I consistently see the failure to attempt any analysis of the hotel electrical system to identify the substantial dollars of electrical that relate to end-using devices that are themselves personal property.

Thus, items are taken as 5 year that should not be, and items are left as 39 year that are entitled to 5 year treatment.

These are just a couple of reasons why a professional cost segregation will pay for itself many times over.

Kent Osborne

Tax Advisors pllc

http://www.costsegteam.com