COST SEGREGATION – MAXIMIZING DEPRECIATION DEDUCTIONS FOR BUSINESS REAL ESTATE

By: David Musser, CPA, CFP®

The current tax laws have been designed to encourage investment in manufacturing, research and development. Cost segregation is one method of encouragement that allows tax deferral through accelerated depreciation deductions. It is used to analyze the capitalized costs of a newly constructed, purchased or existing building in order to maximize depreciation deductions. The costs are segregated into components and are assigned depreciable lives according to MACRS (the Modified Accelerated Cost Recovery System), case law and revenue rulings. The proper segregation of property enables the taxpayer to take advantage of faster depreciation rates allowed for site improvements and personal property.

The basis for classification of site improvements and personal property is Revenue Procedure 87-56 that implements the guidelines set forth in the Tax Reform Act of 1986. Hospital Corp. of America, et al v. Commissioner, 109 TC 21, acq’d in part Ann. 99-116, 1992-2 CB 763, provides that prior law tests developed for purposes of the investment tax credit (ITC) are applicable in determining whether property constitutes tangible personal property or structural components of a building.

Many types of building components can qualify for the shortened depreciation period and accelerated depreciation method. It would be impossible to list them all, but common examples for bank buildings are as listed below. In addition, certain land improvements commonly associated with bank buildings qualify such as landscaping, fences, sidewalks, curbs, parking lots, utilities, outside lighting and signs.

Qualifying Components

• Bank vault doors, bank record doors, night depository facilities, walk-up and drive-up teller’s windows and pneumatic tube systems. These are accessorial to the taxpayer’s business and do not contribute to the maintenance or operation of the building. Revenue Ruling 65-79, 1965-1 CB 26.
• Specialized electrical connections and power supplies for computers, copiers, television hook-ups, ATM’s, time clock (exterior), break room and specialized equipment. These items of property are electrical connections, parts of the secondary electrical system and other connections all of which are necessary for and directly related to the use of specific property. Hospital Corp. of America, et al v. Commissioner, 109 TC 21, acq’d in part Ann. 99-116, 1992-2 CB 763; Morrison Incorporated, et al v. Commissioner, TC Memo 1986-129, aff’d 65 AFTR 2d 90-541 (891 F.2d 857) (11th Circuit 1990); Scott Paper Co. v. Commissioner, 74 TC 137.
• The telephone system and its attendant connections qualify. Hospital Corp. of America, et al v. Commissioner, 109 TC 21, acq’d in part Ann. 99-116, 1992-2 CB 763; Morrison Incorporated, et al v. Commissioner, TC Memo 1986-129, aff’d 65 AFTR 2d 90-541 (891 F.2d 857) (11th Circuit 1990); Scott Paper Co. v. Commissioner, 74 TC 137.
• Window coverings (blinds, curtains, awnings) qualify insofar as the manner of attachment is trivial leading to a degree of permanence that is negligible as the coverings may be easily removed, replaced, or reused elsewhere with no damage thereto. Revenue Ruling 75-178, 1975-1 CB 26.
• Carpeting, vinyl composition tile, vinyl flooring and vinyl wall coverings. Hospital Corp. of America, et al v. Commissioner, 109 TC 21, acq’d in part Ann. 99-116, 1992-2 CB 763; Scott Paper Co. v. Commissioner, 74 TC 137; Whiteco Industries, Inc. v. Commissioner, 65 TC 664; Revenue Ruling 80-151, 1980-1 CB 7.
• Millwork and executive offices millwork that is either decorative in nature or qualifies using the Whiteco criteria. Moreover, such accessorial items are not included in one of the general asset classes of Revenue Procedure 87-56 and are therefore included in asset class 57.0 pursuant to Norwest Corporation and Subsidiaries v. Commissioner, TC Memo 1995-390.
• Specialized plumbing and connections to the break room including piping, valves and other necessary connections. Hospital Corp. of America, et al v. Commissioner, 109 TC 21, acq’d in part Ann. 99-116, 1992-2 CB 763; Morrison Incorporated, et al v. Commissioner, TC Memo 1986-129, aff’d 65 AFTR 2d 90-541 (891 F.2d 857) (11th Circuit 1990); Duaine v. Commissioner, TC Memo 1985-39; Revenue Ruling 66-299, 1966-2 CB 14.
• Break room counters and cabinets qualify when subjected to the Whiteco criteria cited below and pursuant to Metro National Corp. v. Commissioner, TCM 1987-38. Whiteco Industries, Inc. v. Commissioner, 65 TC 664; Revenue Ruling 80-151, 1980-1 CB 7; Revenue Ruling 75-178, 1975-1 CB 9.
• Interior security fence and gates qualify using the Whiteco criteria: (1) the property is capable of being moved; (2) the property is designed to remain in place indefinitely; (3) length of affixation is dependent solely on extraneous factors; (4) removal of the fence and gate is easily accomplished; (5) the property will sustain no damage upon removal; and, (6) the property is affixed to fence posts using normal construction methods. Whiteco Industries, Inc. v. Commissioner, 65 TC 664; Revenue Ruling 80-151, 1980-1 CB 7.
• Removable partitions are qualifying property with respect to the Whiteco criteria. Whiteco Industries, Inc. v. Commissioner, 65 TC 664; Revenue Ruling 80-151, 1980-1 CB 7; Hospital Corp. of America, et al v. Commissioner, 109 TC 21, acq’d in part Ann. 99-116, 1992-2 CB 763; Morrison Incorporated, et al v. Commissioner, TC Memo 1986-129, aff’d 65 AFTR 2d 90-541 (891 F.2d 857) (11th Circuit 1990); Minot Federal Saving & Loan Association v. United States, 435 F.2d 1368, (8th Circuit 1970).
• Decorative lighting qualifies pursuant to Metro National Corp. v. Commissioner, TCM 1987-38 and insofar as its use is only incidental to the operation or maintenance of the building whereby it qualifies as “special lighting” mentioned in Senate Finance Committee Report for the 1978 Revenue Act (Pub. L. 95-600), S. Report 95-1263 (1978), 1978 C.B. (Vol. 1) 321, 415.

Our approach is to extract data from cost records of newly constructed buildings. From these records, we can identify qualifying costs and allocate any overhead and profit to derive the total capital costs for each specific asset class. If the records aren’t available, we can coordinate our plan with an experienced engineer or architect. We have access to engineers and architects that are experienced in this area and work with them under a team approach. These professionals must be used for cost segregation studies of existing buildings or recent purchases of existing buildings.

If you recently purchased a building or constructed a building in the last ten years and are not certain whether all of the depreciation allowed for has been taken and would like immediate tax savings please contact us by Email or phone at 800-823-0117.

Contact Nichols, Cauley & Associates by Email, phone, or online form with your questions.

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