Earlier this week President Obama introduced his 2012 budget proposal.  While we acknowledge that this budget is unlikely to pass in its current form, the proposals give insight into what some government officials are considering for future tax policy.

We have reviewed the President’s proposal and put together a brief summary of some key areas that would affect specialty tax in the coming years:

Enhance and Make Permanent the Research and Experimentation Tax Credit

o   The proposal calls for making it permanent and increasing the rate of the alternative simplified credit from 14 to 17 percent effective 12/31/11.

Provide Additional Tax Credits for Investment in Qualified Property for Advanced Manufacturing Projects

o   Provides a 30 percent tax credit for investments in eligible property used in a qualifying advanced energy project

o   Projects would expand, re-equip, or establish a manufacturing facility for the production of:

• Alternative energy property
• Fuel cells, micro turbines, or batteries for electric cars
• Electric grids for renewables
• Property designed to capture CO2 emissions
• Property designed to refine or blend renewable fuels
• Electric vehicles
• Other advanced energy property

o   Sets a $5 billion cap on credits

Change 179D to a Credit

o   Sets 179D as a credit instead of a deduction

o   Changes the reference to ASHRAE 90.1-2004 from 90.1-2001

o   Changes the credit calculation to the following:

• 20 percent reduction – $0.60/sf
• 30 percent reduction – $0.90/sf
• 50 percent reduction – $1.80/sf

o   Special rules would be implemented for REITs, but those rules have not been specified.  It is also not referenced how this would affect designers.

Extend 1603 Grant on Alternative Energy Property through 2012

End LIFO Accounting

Extend 15-year life on Qualified Leasehold, Restaurant and Leasehold improvements through 12/31/12

Extend 100 percent Bonus Depreciation through 12/31/12

Extend WOTC

45L Credit for the construction of energy efficient homes would be extended for 2012

This budget also includes a number of other changes, including loophole closures and potential changes to AMT.  Treasury has put out a summary document explaining the proposals.  The full text of the Treasury Document can be found here.

As stated, the proposals listed are just proposals and carry no weight unless passed.  However, it is important to know the policies and proposals being discussed when planning for the 2012 tax year.  If you have any questions feel free to contact us directly.

By David McGuire, Director
dmcguire@mcguiresponsel.com

Over the last week I have been asked several questions about the case Peco Foods, Inc. & Subsidiaries, v. Commissioner of Internal Revenue (T.C. Memo 2012-18). I have been asked questions such as, “Does this mean we can’t do cost segregation studies on purchases?” or “How will this affect the industry?”

The court case follows the company Peco Foods. In the mid-1990′s Peco purchased two chicken processing plants. These plants were purchased as assets requiring a breakdown of the costs as stipulated in Section 1060 of Internal Revenue Code. Peco and the seller agreed to a detailed allocation and filed a form 8594. A few years later Peco contracted someone to complete a cost segregation study adjusting the amount associated with building on the 8594. The IRS’s position, which was sustained by the court, was that the lives could not be adjusted on a 3115. The section 1060 allocations are considered permanent and cannot be adjusted after the fact.

This is not a new opinion. In fact, there are other cases stating very similar fact patterns. In Spector vs. Commissioner it was stated “in none of these decisions did this Court allow a taxpayer, having voluntarily and at arms-length bargained for a particular form of transaction, with complete foreknowledge of the tax consequences flowing therefrom, and having represented to the Commissioner that the chosen form reflected the true nature of the transaction, to disavow that form as a sham designed for the sole purpose of misleading the Commissioner, and, having already received substantial nontax benefits therefrom, adopt one with more favorable present tax consequences…” In other words, the courts do not want one side of a purchase adjusting without the other side adjusting as well to keep things even.

The Peco Foods case is mostly a restatement of long standing policy, and a reminder of certain important tax issues. The case does not establish a drastic change in policy, but rather spotlights very important issues which are frequently overlooked.

The case does bring up some interesting questions. Should a taxpayer be less detailed in the filing of the 8594? The form 8594 lumps all depreciable assets into category V. Can a buyer and seller agree to the total amount of class V property without agreeing to the allocation between 1245 and 1250? Should a cost segregation study be completed prior to the purchase? These questions and others are complicated and require conversations not only with a depreciation expert, but also with the CPA involved.

Two things are certain based on this case. It is very important to get the experts involved early in an asset purchase. Too often if there are not immediate tax consequences these issues are held off for a year or two. Based on this case, and others like it, this course of action could be a mistake. Also it shows the importance of making sure the 8594 is filed effectively. Discussions with experienced providers need to take place prior to the filing of this form, which is often seen as an afterthought.

Although tax season is upon us, this issue is important and could affect many taxpayers this year. Due to this McGuire Sponsel is having a webinar to discuss this issue on Friday, February 3 at 11 a.m. EST. To register please click here.

For years McGuire Sponsel has discussed the importance of utilizing qualified professionals when completing cost segregation studies. A recent court decision in Oregon, Ronald Pearce and Daryl Pearce, Plaintiffs, v. Department of Revenue, State of Oregon, Defendant, once again illuminated the importance of completing a quality study. The Oregon Tax Court upheld the need to utilize qualified professionals when completing a cost segregation study.

The plaintiffs in this case owned rental real estate and decided to complete their own cost segregation study on their properties. Although the plaintiffs had little to no experience with cost segregation, they utilized a “rule of thumb” approach to complete a cost segregation study on their 2004 tax return. The accelerated depreciation deductions were carried forward into the 2006 and 2007 tax returns which were audited.

The IRS cited the Audit Technique Guide (ATG) in their argument. The IRS stated that the “rule of thumb approach” lacked “sufficient documentation to support its allocation of project costs”. Furthermore, they listed the principle elements of a quality cost segregation study, including element number one “preparation by an individual with expertise and experience”.

Although the 2004 tax return was closed, the IRS was allowed to examine the 2004 tax year to recalculate depreciation deductions relating to the 2006 and 2007 tax years.

While this may seem like an extreme situation, it is actually quite common. We have seen many examples of people taking arbitrary amounts as personal property. They rely on “experience” or engineering firms with little tax background to complete cost segregation studies. This court case further emphasizes the importance of understanding the expertise of the people completing your tax work.

Click here to download a full transcript of the decision.

By David McGuire, Director
dmcguire@mcguiresponsel.com

Many multi-family residential rental complexes are overlooking a cost segregation study as a noteworthy tax saving opportunity. The accelerated depreciation deductions from asset reclassification can generate large tax deductions and produce substantial cash flow benefits. On average, 20 percent of urban assets and 30 percent of suburban assets can be reclassified.

A cost segregation study on multi-family residential complexes can be performed efficiently and cost effectively by studying just the unique units. Recently, McGuire Sponsel performed a cost segregation study on a 170-unit complex that had consistent unit sizes and finishes throughout. The $1.8 million investment, not inclusive of land value, was reviewed the same tax year the property was capitalized and purchased. Our study allowed significant reclassification of assets, including $7,000 of land improvement property with a 15 year life and $300,000 of personal property with a five year life. The accelerated depreciation resulted in $125,000 in increased cash flow over the first five years. This increased cash flow resulted in a net present value benefit in excess of $114,000.

New properties aren’t the only opportunity. A cost segregation study can still be beneficial when completed after the purchase, construction or renovation date. A notable example of this is a 50-unit multi-family residential rental complex. Like the above example, this property had a $1.8 million investment, not inclusive of land value. McGuire Sponsel performed a cost segregation analysis in 2010 even though the property was purchased in 2009. Asset classifications generated a 481 (a) catch up adjustment of $18,000, recognized as a reduction to 2010 taxable income. Reclassification of assets resulting from our study yielded $8,000 of land improvement property with a 15 year life and $400,000 of personal property with a five year life. The accelerated depreciation resulted in $128,000 in increased cash flow over the first five years. This increased cash flow resulted in a net present value benefit in excess of $71,000.

Having an experienced partner assess your property will ensure you receive substantial tax savings and cash flow benefits. Contact McGuire Sponsel today to learn more about how you can benefit from a cost segregation analysis.