Cost Segregation and Tangible Property Regulations Update – Preparing for IRS Examinations: • An introduction to the recently released IRS Audit Techniques Guide as it relates to tangible property regulations • Potential tax issues and IRS focus areas related to cost segregation projects • Other recent tax depreciation updates

1. CohnReznick is an independent
member of Nexia International
Presented by: Richard Shevak and
Derek Weaver
C o s t S e g r e g a t i o n a n d Ta n g i b l e
P r o p e r t y R e g u l a t i o n s U p d a t e –
P r e p a r i n g f o r I R S E x a m i n a t i o n s

2. P U R P O S E
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The purpose of this course is to provide updates in connection with IRS
guidance and examination activity in connection with cost segregation and
other fixed asset studies. Additionally, we will discuss several technical issues
that could create examination risk if not dealt with properly.
January 11, 2017

3. A G E N D A
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 Audit Techniques Guide for Tangible Property Regulations
 Audit Techniques Guide for Cost Segregation
 AmeriSouth Case Discussion
 Other Technical Issues
 Bonus Depreciation and §179 Update
January 11, 2017

4. B E F O R E W E B E G I N …
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 What are the Tangible Property Regulations?
– Repair issues
– Acquisition cost issues
– Materials and supplies
– Dispositions
 What is a Tangible Property Regulations Study?
 What is a cost segregation study?
January 11, 2017

5. A u d i t Te c h n i q u e s G u i d e ( AT G ) f o r
Ta n g i b l e P r o p e r t y R e g u l a t i o n s
( T P R )

6. TA N G I B L E P R O P E R T Y
R E G U L AT I O N S H I S T O R Y
5
 Several prior versions of the regulations.
– Before the final regulations, many taxpayers were filing Forms 3115
based on prior case law.
 Final Regulations: Effective tax years beginning on or after 1/1/2014.
January 11, 2017

7. I R S A U D I T T E C H N I Q U E S G U I D E
6
 September 14, 2016 – IRS released an Audit Technical Guide related
to the Tangible Property Regulations (TPR).
 Provides specific guidance for IRS examiners to identify potential tax
issues related to capitalization and dispositions of tangible property.
 Almost 200 pages long with 18 chapters; each chapter contains a
summary of the law and is followed by “Audit Procedures.”
 The Audit Procedures contain questions to be asked by the IRS
agent, facts to consider, and information to be requested by the
agent.
January 11, 2017

8. I R S A U D I T T E C H N I Q U E S G U I D E
( c o n t . )
7
 “General” chapter instructs IRS agents to ask if the taxpayer
performed a prior TPR study. If so, the agents are asked to consider:
– Years affected by the study.
– Assets affected by the study.
– How the taxpayer determined which assets to analyze (i.e., did the
taxpayer “cherry-pick”?).
– Did the taxpayer properly define units of property (UOP)?
– Information (support) considered when performing the analysis.
 Note: Insufficient information may cause the IRS to deny certain
deductions.
– Computation of Schedule M adjustments (book/tax differences).
January 11, 2017

9. A U D I T T E C H N I Q U E S G U I D E
H I G H L I G H T S
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Unit of Property Change
 Did the taxpayer properly apply the UOP rules?
– Did the taxpayer analyze the building expense on a “system by
system” basis?
 Did the IRS agent specifically consider any Section 481(a)
adjustment?
– The IRS will check to make sure you reduced the basis in your
depreciable assets and are not “double-dipping.”
 Did the IRS agent determine the type of property that would be
impacted by the change?
January 11, 2017

10. A U D I T T E C H N I Q U E S G U I D E
H I G H L I G H T S ( c o n t . )
9
Amounts Paid To Acquire Or Produce Property
 Are there any capitalizable indirect acquisition or costs that the
taxpayer deducted?
– Acquired assets: Did the taxpayer capitalize the list of facilitative
costs contained in the regulations?
– Produced assets: Did the taxpayer properly apply 263A?
Improvement Rules (Betterment, Restoration, New, Or Different
Use)
 Did the taxpayer perform its TPR analysis in accordance with the final
regulations?
– Did the taxpayer apply all of the appropriate tests?
– Betterment, Restoration, New, or Different Use
January 11, 2017

11. A U D I T T E C H N I Q U E S G U I D E
H I G H L I G H T S ( c o n t . )
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De Minimis Safe Harbor
 Does the taxpayer have an applicable financial statement?
 If so, did it have a written policy in place as of the first day of the tax
year?
 Does the company actually follow that policy (Consistency)?
 Did the taxpayer properly identify the asset to which it applied de
minimis? (Example: If you received two invoices for a single asset
that were each under the de minimis threshold, but were more – in
total – than the de minimis limit.)
Routine Maintenance Safe Harbor (RMSH)
 Did the taxpayer apply the RMSH appropriately?
– Did it apply the RMSH to property that was improved or adapted to
a new or different use?
January 11, 2017

12. A U D I T T E C H N I Q U E S G U I D E
H I G H L I G H T S ( c o n t . )
11
Leased Property
 Does the taxpayer own or lease property?
 Was Section 110 properly applied to leased property (related to the
receipt of tenant improvement allowances)?
– The IRS will ask whether the income a tenant received was
recognized as income. If not, they will ask why Section 110 applies
to prevent revenue recognition.
– Book treatment for tenant improvement allowances is typically NOT
appropriate for tax purposes.
January 11, 2017

13. A U D I T T E C H N I Q U E S G U I D E
H I G H L I G H T S ( c o n t . )
12
Materials and Supplies
 How does the taxpayer account for materials and supplies?
– Are they deducted immediately or deducted when “consumed”?
– Are materials and supplies properly defined?
 Are materials and supplies (for a producer) properly capitalized to
inventory?
 Are materials and supplies actually spare parts related to a piece of
equipment?
 Is the taxpayer using the de minimis safe harbor?
January 11, 2017

14. A U D I T T E C H N I Q U E S G U I D E
H I G H L I G H T S ( c o n t . )
13
Dispositions
 Has the taxpayer has performed a “disposition” study?
 What is the extent of the study (refer to the engagement letter and
presentation materials)?
 Were any basis adjustments recorded on an asset by asset basis?
 An IRS agent considers whether the property deducted as a
disposition was actually disposed (similar to an abandonment
analysis).
January 11, 2017

15. AT G f o r C o s t S e g r e g a t i o n S t u d i e s

16. O U T L I N E O F AT G
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 8 chapters
 Cost Segregation Methodologies: Chapter 3
 Principal Elements of a Quality Cost Segregation Study: Chapter 4
 Chapter 5 provides suggested audit steps for reviewing and
examining a cost segregation study and report.
 Chapters 7 & 8 provide the Industry Specific Guidance and Issue
Specific Guidance.
January 11, 2017

17. C O S T S E G R E G AT I O N A U D I T
T E C H N I Q U E S G U I D E
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 Assists IRS examiners with review and examination of cost
segregation studies.
 Provides IRS examiners with an understanding of:
– Why cost segregation studies are performed for tax purposes;
– How cost segregation studies are prepared;
– What to look for in the review and examination; and,
– When certain issues identified in the study need further
examination.
 In some cases, IRS examiners may require specialists with expertise,
industry experience, and specialized training (e.g., engineers,
computer audit specialists, and/or DCE PN Senior Revenue Agents).
January 11, 2017

18. C O S T S E G R E G AT I O N
E X A M I N AT I O N S T E P S
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1. Review the cost segregation study report for initial risk analysis
purposes.
2. Verify the cost basis and reconcile depreciation records.
3. Conduct a risk analysis to evaluate audit potential.
4. Review the cost segregation study report for examination purposes.
5. Interview the cost segregation study preparer.
6. Inspect the property.
7. Review and verify the asset classes and recovery periods of
property.
January 11, 2017

19. C O S T S E G R E G AT I O N
E X A M I N AT I O N S T E P S ( c o n t . )
18
8. Research the law, the regulations, and appropriate rulings.
9. Cost analysis.
10.Summarize the findings and discuss the challenged assets with the
taxpayer.
11.Prepare the final report or the Notice of Proposed Adjustments (if
necessary).
12.Review sampling techniques (if necessary).
13.Consider §263A.
14.Consider change in accounting method.
January 11, 2017

20. D i s c u s s i o n o f t h e A m e r i S o u t h
C a s e

21. C A S E F A C T S
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 AmeriSouth XXXII, Ltd. bought an apartment complex in 2003 for $10.25
million.
 AmeriSouth claimed on its returns that the water-distribution and
sanitary-sewer systems, the gas lines, and the site electric were eligible
for 15-year depreciation.
 AmeriSouth claimed property in the other categories was eligible for 5-
year depreciation.
 The taxpayer's argument was challenged by the IRS Commissioner.
 AmeriSouth sold the apartment complex before the case made it to trial.
 Conclusion:
– Tax Court allowed 5 and 15-year treatment on certain items.
– Tax Court disallowed some 5 and 15-year assets.
Some were disallowed because taxpayer did not present evidence.
Analysis involved whether certain items were “necessary” in a building.
January 11, 2017

22. O t h e r Te c h n i c a l I s s u e s

23. C O S T S E G R E G AT I O N S :
R E L I N Q U I S H E D P R O P E R T Y
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 Relinquished property: Before a 1031 transaction.
 If you performed a cost segregation on a property and THEN use that
property as the relinquished property in a 1031 transaction, you may
have potential recapture issues.
– If the relinquished property has more 1245 than the replacement
property, there will be a recapture issue.
– If the relinquished property has less 1245 property than the
replacement property, then you will not have a recapture issue.
 If the relinquished property was the subject of a cost segregation
study, the opportunity here might be to do a cost segregation on the
replacement property to avoid recapture issues.
January 11, 2017

24. C O S T S E G R E G AT I O N S :
R E P L A C E M E N T P R O P E R T Y
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 Replacement property: After a 1031 exchange.
 Application of the rules under §168:
– Exchange basis: General rule
– Exchange basis: Election
– Excess basis: Rule
January 11, 2017

25. TA X - E X E M P T O W N E R A N D
T E N A N T R U L E S
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Tax-exempt Owners:
 If the entity is owned partially by tax-exempt members, the portion of
ownership related to the tax-exempt owners would have an ADS
depreciation allocation/split for each asset class if you do not have a
qualified allocation.
 For example, if a residential rental property is owned 40% by tax-
exempt members, 40% of what would typically be 27.5-year basis
would be depreciated using 40-year ADS. 40% of the personal
property would have an ADS allocation (40% 5/9-year ADS vs. 60%
5-year MACRS). The same would be true for land improvements and
other types of property in the entity.
January 11, 2017

26. TA X - E X E M P T O W N E R A N D
T E N A N T R U L E S ( c o n t . )
25
Tax-exempt Tenants:
 1250 Property: If the tax-exempt tenant occupies 35% or more of the
building and is doing so in a disqualified lease, the 1250 property would
be depreciated using ADS (40-year ADS instead of 39-year MACRS
property).
 1245 Property:
– The personal property in tax-exempt tenant space should be
depreciated over the greater of 125% of the tenant’s lease term,
including options to renew or the designated ADS class life for the
property. For example, the ADS class life for office furniture is 10-year
ADS.
– If the tax-exempt tenant’s lease term is 15 years and the tenant has a
5-year renewal option after the initial lease term, the office furniture
should be depreciated over 25 years using ADS straight-line
depreciation (15 year lease term + 5 year option = 20 years x 125% =
25-year ADS).
January 11, 2017

27. P R O P E R T Y P U R C H A S E D W I T H
T H E I N T E N T T O R E M O D E L
26
 If a company or taxpayer purchases a property with an immediate
plan to renovate the property (say in the first year or so), this limits
our ability to identify personal property or disposition basis in the
acquisition cost related to assets removed/demolished as part of the
renovation.
 In other words, if a company or taxpayer knew they were retiring or
demolishing property subsequent to purchase, the basis in the
demolished property has very little or no value.
 Often, the buyer negotiates a lower purchase price based on the
anticipation of a large spend for a subsequent remodel project.
January 11, 2017

28. P R O P E R T Y P U R C H A S E D W I T H
T H E I N T E N T T O R E M O D E L ( c o n t . )
27
 For example, if a company or taxpayer purchased an apartment
complex and they knew they were going to replace all the carpeting
and cabinetry as part of a subsequent remodel project immediately
after purchase, the old carpet and cabinets have little to no value or
depreciable basis at acquisition.
 Depending on the extent of the remodel project, it often does not
make sense to perform a cost segregation study on the acquisition
basis. The cost segregation opportunity might then lie with the
subsequent remodel project.
January 11, 2017

29. B o n u s D e p r e c i a t i o n a n d § 1 7 9
U p d a t e
P r o t e c t i n g A m e r i c a n s f r o m T a x H i k e s A c t
o f 2 0 1 5 ( “ P A T H ” )

30. PAT H A C T – B O N U S
D E P R E C I AT I O N U P D AT E
29January 11, 2017
Old Rule
 Property with a recovery period
of 20 years or less
 Computer software
 Water utility property
 Qualified leasehold
improvement property
New Rule
 Property with a recovery period
of 20 years or less
 Computer software
 Water utility property
 Qualified improvement
property
 Extends Bonus Depreciation to
2019

31. Q U A L I F I E D I M P R O V E M E N T
P R O P E R T Y D E F I N I T I O N
30
 Beginning in 2016, “Qualified Improvement Property” replaces
Qualified Leasehold Improvement Property (QLIP) in the list of
bonus-eligible property.
 Broader Definition:
– Defined similarly as QLIP, except that the interior improvements do
not need to be made pursuant to a lease, the improvements do not
need to be to tenant space, and there is no 3-year requirement.
 Qualified Improvement Property is any improvement to an interior
portion of a building that is nonresidential real property if the
improvement is placed in service after the date the building was first
placed in service, excluding: 1) enlargements; 2)
elevators/escalators; and 3) internal structural framework.
January 11, 2017

32. B O N U S R AT E S B Y Y E A R S
31January 11, 2017

33. PAT H A C T – S E C T I O N 1 7 9
U P D AT E
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The following are made permanent:
 $500,000 limit
 $2,000,000 phase-out
 Ability to use 179 for computer software
 Ability to use 179 for qualified real property
– $250k limit (and corresponding carry-forward language) deleted.
 Inflation adjustment added
 Ability to use 179 for air conditioning and heating units
January 11, 2017

34. C O S T S E G R E G AT I O N
C O N F E R E N C E TA K E - A W AY S
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 The number of IRS agents tasked with auditing cost segregation
studies has diminished somewhat over the years.
 The AmeriSouth case is largely ignored when considering whether to
do a study on residential rental property.
 Practitioners are considering the implications of the TPR when
conducting cost segregation studies.
January 11, 2017

35. Richard Shevak, JD, Director
CohnReznick LLP
4 Becker Farm Road
Roseland, NJ 07068
862.245.5029
Richard.Shevak@CohnReznick.com
Derek Weaver, Senior Manager
CohnReznick LLP
7501 Wisconsin Avenue
Suite 400E
Bethesda, MD 20814
301.280.2727
Derek.Weaver@CohnReznick.com
www.CohnReznick.com