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Copyright © 2016 Marks Paneth LLP

ACCELERATED COST RECOVERYDEPRECIATION REFRESHER

Michael W. Hurwitz, CPA, MSTJanuary 17, 2017

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CAPITALIZED COSTS V. PERIODIC OPERATING EXPENSESBALANCE SHEET V. INCOME STATEMENT

WHAT ARE WE TALKING ABOUT TODAY?

• Operating expenses (do not increase value) • Abandoned dead deal costs• Natural resources• Organizational and start-up costs (180 months)• Acquisition costs • Lease termination fees • Betterment, restoration or adaptation (repair regulations)

Property that is depreciated is tangible property used in a trade or business or held for the production of income that has a determinable

exhaustible useful life!

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DEPRECIATION – MAJOR LEGISLATIONINTERNAL REVENUE CODE SECTION 168

• Before 1981, tax depreciation methods closely resembled financial accounting methods which required businesses to determine “Salvage Values” and “Useful Lives”.

• In 1981, Accelerated Cost Recovery System (ACRS) was introduced to depreciate assets over predetermined, fixed recovery periods.

• Pursuant to the Tax Reform Act of 1986, today businesses calculate their tax depreciation using the Modified Accelerated Cost Recovery (MACRS).

Consider looking over Publication 946 (How to Depreciate Property) for a complete discussion on MACRS; not applicable to assets placed in service

pre-1987!

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DEPRECIATION - SOME TERMINOLOGY

• Cost recovery [tax purpose]• Adjusted tax basis - depreciation expense and rolling of assets • New Repair Regulations - finalized on 9/17/2013 • Section 1245 Property: 1/2 year or mid 1/4 convention for personal

property• Section 1250 Property: straight-line mid-month for real property• Depreciation methods• Immediate expensing - Section 179 expense• Bonus depreciation• Cost segregation studies

Revenue Procedure 87-56; a detailed list of recovery classes, class lives and periods assigned to property added by the Tax Reform Act of 1986!

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COST RECOVERY

Businesses must capitalize certain costs / expenditures for assets with useful life of more than one year onto the balance sheet rather than toexpense the costs currently on the income statement. Different methods torecover theses costs apply to different assets (depends on the nature of theunderlying asset.

• Depreciation: deducting the cost of tangible personal (Section 1245) and real (Section 1250; other than land) property over a specific period of time.

• Amortization: deducting the cost of intangible personal and real property (other than land) over a specific period of time.

• Depletion: deducting the cost of natural resources over time.

Business use these methods to recover cost of assets due to wear, tear and obsolescence of assets.

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ADJUSTED TAX BASIS

• Once the use of purchased assets is started / it’s placed in service, recouping the cost of assets also begins.

• Cost basis is reduced when cost is recovered through cost recovery deductions; the assets adjusted basis and / or net tax basis remains.

• Assets adjusted basis equals the assets initial cost or historical basis plus additions minus accumulated depreciation (amortization or depletion) and dispositions.

Who maintains and tracks detailed schedules [cost basis and accumulated depreciation]? Why is this important?!?

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ADJUSTED TAX BASIS

To compute MACRS depreciation expense for an asset, the followinginformation needs to be known:

1. asset’s original / initial cost basis,

2. applicable depreciation method,

3. asset’s recovery period (or depreciable life), and the

4. applicable depreciation convention

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REPAIR REGULATIONS

IRC Section 162 allows one to deduct all the ordinary and necessary expenses you incur during the taxable year in carrying on your trade or business, including the costs of certain materials, supplies, repairs, and

maintenance. That said, IRC Section 263(a) requires you to capitalize the costs of acquiring, producing, and improving tangible property, regardless of the size or the cost incurred. The tax law has long required you to determine

whether expenditures related to tangible property are currently deductible business expenses or non-deductible capital expenditures. The final tangibles

regulations (commonly referred to as the Repair Regulations) combine the existing case law, prior administrative rulings and other authorities into a

framework to help taxpayers determine whether certain costs / expenditures are currently deductible or must be capitalized and recovered through depreciation. The final tangibles regulations contain several simplifying

provisions that are elective and prospective in application.

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REPAIR REGULATIONS

• De Minimis safe harbor election; Notice 2015-82 increased threshold from $500 to $2,500 per item without applicable financial statements (in accordance with clients written accounting procedures – policy) / yearly statement is to be incorporated in the federal filing: Section 1.263(a)-1(f)

• Yearly election to utilize the safe harbor for small taxpayers [gross receipts less than $10M, buildings unadjusted tax basis is $1M or less and the cost of expenditures do not exceed the lesser of 2% of the basis of the eligible property or $10K] - - I do not see this being applicable for our landlord

• Election to capitalize repairs and maintenance costs in accordance with the taxpayers books and records [administrative convenience]

• Not required to capitalize routine maintenance expenditures

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REPAIR REGULATIONS

The improvement analysis for distinguishing a capital improvement from a deductible repair applies to the building structure and each of the key building systems (unit of property). The key building systems are the:1. plumbing system, 2. electrical system, 3. HVAC system, 4. elevator system, 5. escalator system, 6. fire protection and alarm system, 7. gas distribution system, and 8. the security system

Let’s discuss lobby’s, roofs, parking lots and the outer building shell!

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REPAIR REGULATIONS

A unit of tangible property is improved only if the amounts paid is for :

1. A betterment pursuant to Treasury Regulation Section 1.263(a)-3(j)

2. A restoration pursuant to Treasury Regulation Section 1.263(a)-3(k) or

3. An adaptation pursuant to Treasury Regulation Section 1.263(a)-3(l)

Review the definitions of these words…

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DEPRECIATION METHODS

Depreciation Methods: three acceptable methods for depreciating property

1. 200 percent (double) declining balance (personal property - Section 1245 / class life’s of 3, 5, 7 and 10 years): applicable for all tangible property such as computers, automobiles, furniture, machinery and equipment, other than real property; note: personal property (not real property) and personal use property (used for personal purposes) not the same!

2. 150 percent declining balance (land improvements / class life of 15 years)

3. straight-line (real property - Section 1250: both commercial and residential of class life’s of 39 years and 27.5 years, respectively)

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DEPRECIATION: PERSONAL PROPERTYHALF-YEAR CONVENTION

• Half year’s depreciation expense is allowed in first and last year of an asset’s life.

• The IRS depreciation tables automatically account for the half-year convention.

• If an asset is disposed of before it is fully depreciated, only one-half of the table’s applicable depreciation percentage is allowed in the year of disposition.

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DEPRECIATION: PERSONAL PROPERTYMID-QUARTER CONVENTION

Steps to determine whether the mid–quarter convention applies

1st add up the total basis of tangible personal property that was placed in service during the entire year;

2nd add up the total basis of tangible personal property that was placed in service during the 4th quarter of the year;

Divide step (2) by step (1); if the quotient is more than 40%; then the business must use the mid-quarter convention!

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DEPRECIATION: REAL PROPERTYMID-MONTH CONVENTION

Real Property uses the mid-month convention which required using a straight line method over specific number of years:

• Residential real property is recovered over 27.5 years

• Nonresidential real property is recovered over 39 years*

Note * property placed in service post May 13, 1993 is recovered over 39 years; property placed in service prior to said date is recovered over 31.5 years (have any of you seen assets being recovered over 31.5 years)?

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IMMEDIATE EXPENSINGIRC SECTION 179 DEDUCTION

The Protecting Americans from Tax Hikes (the PATH Act) was passed and signed into law on December 18, 2015. This bill expanded and made

permanent the Section 179 deduction to $500,000. This amount will be indexed to inflation in $10,000 increments in future years. Taxpayers

exceeding a total of $2 million of purchases of qualifying property have the deduction phased-out dollar-for-dollar and completely eliminated above $2.5 million. Qualifying property must be purchased and put into service during the year in which the deduction is being taken. Qualifying property includes, machinery, office furniture, equipment, computers, software and

even property attached to the building as long as it’s not a structural component of the building.

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BONUS DEPRECIATION

To stimulate the economy, policy makers occasionally implement bonus depreciation; an incentive for taxpayers to purchase assets. The PATH Act also extends bonus depreciation for property placed in service through 2019*. Bonus Depreciation is a method of accelerated depreciation which allows a taxpayer to take an additional deduction of 50% (for 2016) of the cost of qualifying property that meet the following requirements: • New MACRS property with recover period of 20 years• Qualified improvement property {replaced qualified leasehold

improvement property however, its a much broader definition}• Original use must begin with the taxpayer and • Placed in service before January 1, 2020

* The bonus deduction amount will be at 50% 2017, reduced to 40% for 2018 and further reduced to 30% for 2019. 

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DEPRECIATION AND AMORTIZATIONAN ANNUAL DEDUCTION ON FEDERAL FORM 4562

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DEPRECIATION SAMPLE TABLEHALF-YEAR CONVENTION

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DEPRECIATION SAMPLE TABLEMID-QUARTER CONVENTION – 4TH

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DEPRECIATION SAMPLE TABLEMID-QUARTER CONVENTION – 1ST

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DEPRECIATION SAMPLE TABLESTRAIGHT LINE – 27.5 YEARS [RESIDENTIAL PROPERTY]

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EXAMPLES: CALCULATING DEPRECIATIONINPUTTING INFORMATION INTO PROFX

Input and calculate depreciation in ProFX for current acquisitions:

1) Various personal property placed in service throughout the year[$10,000 furniture in January and $10,000 furniture in August]

2) An A+ residential office building in NYC[40,000,000 in March]

3) Demonstrate the Section 179 deduction[$25,000 equipment in January]

4) Demonstrate the bonus depreciation[$150,000 in September]

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EXAMPLES: CALCULATING DEPRECIATIONPROFX OUTPUT OF INFORMATION

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EXAMPLES: CALCULATING DEPRECIATIONFEDERAL FORM 4562

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COST SEGREGATION STUDIESWHAT ARE THEY?

The process of identifying personal property assets that are grouped in withreal property assets; the goal of which is to reclassifying these costs to

ultimately accelerate current depreciation deductions!

Advantages:• Enhanced depreciation benefits (more deductions sooner than later)• Front loads depreciation• Time value money• Easily identifies assets to be written-off Disadvantages:• Cost of study• Early disposition of property triggers recapture of tax benefits• Improper engineering studies- severe tax penalties

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COST SEGREGATION STUDIESPROPERTY ELIGIBILITY

Includes buildings purchased or constructed, expanded or remodeled since 1987; most efficient for newly constructed buildings; many time results uncover retroactive tax deductions from older assets…

Properties eligible for cost segregation study:1 - Hotels2 - Nursing Homes3 - Office Buildings4 - Shopping Centers5 - Apartment Complexes6 - the list goes on…

All Rights of Use and Reproduction Reserved

Copyright © 2016 Marks Paneth LLP

ACCELERATED COST RECOVERYDEPRECIATION REFRESHER

Michael W. Hurwitz, CPA, MSTJanuary 17, 2017