Significant growth in capital expenditures can strain a company’s cash flow and debt capacity. Whether purchasing, constructing, expanding or renovating a facility, the associated costs accumulate quickly.
Utilizing federal income tax laws, construction cost estimation and appraisal methodologies, cost segregation studies can counteract this cash flow strain by aiding in the identification of those costs that qualify for accelerated depreciation methods over shorter periods and creating a significant tax deferral.
In recent years, the value of cost segregation studies has escalated as Congress has passed new laws and the Internal Revenue Service has issued new rulings resulting in the acceleration of these tax benefits.
Congress increased depreciation benefits in 2002 when it passed the Job Creation and Worker Assistance Act of 2002 and introduced bonus depreciation. This statute enhanced the benefits of cost segregation by permitting a 30 percent deduction of the eligible cost in the current period, with the remaining 70 percent eligible for regular depreciation deduction treatment.
In 2003, the Jobs and Growth Tax Relief Reconciliation Act of 2003 improved these benefits further when Congress temporarily increased the limit of current year bonus depreciation to 50 percent of qualifying assets. Unfortunately, bonus depreciation will expire at the end of 2004.
Coupled with Congress’ statutory changes regarding bonus depreciation, recent IRS pronouncements also support cost segregation studies. In March 2002, the IRS improved the tax benefit available for prior year investments that had not been properly classified when originally capitalized by issuing Revenue Procedure 2002-19.
Preceding IRS regulations had permitted the adjustment of the depreciation recovery periods on assets previously placed in service and to capture catch-up depreciation that should have been realized in prior years.
This catch-up depreciation was treated as an accounting method change and was computed in accordance with Section 481(a) of the Internal Revenue Code, commonly known as the 481(a) adjustment. However, prior to 2002, the IRS required taxpayers to spread the adjustment over four years from the year of the change. The new regulations eliminated the prior four-year spread and allowed taxpayers to report 100 percent of the 481(a) adjustment in the current year of the change.
The IRS issued clarifying Temporary Regulation 1.446-1T (e) (2) in December 2003 to remove vague language and corresponding uncertainty in the regulations about accounting method changes. The clarification left no doubt as to a taxpayer’s eligibility to file IRS Form 3115 and therefore granted automatic consent from the IRS to make changes in depreciation methods.
This same month, the IRS also issued Revenue Procedure 2004-11, waiving a previous rule that required a taxpayer to wait two years before correcting a change in an accounting method.
In January 2004, the IRS further encouraged cost segregations when it outlined approved cost segregation processes and asset classifications in its Cost Segregation Audit Techniques Guide (CSATG). This thorough manual covered both tax and nontax aspects of cost segregation and, more important, clearly identified the IRS’ position on the tax classification of a number of different property types.
All of these recent legislative and regulatory changes have made it easier for companies to begin realizing the return on their investment faster. Bonus depreciation may soon be gone; nevertheless, these new developments make cost segregation studies more instantly beneficial.
Consequently, companies should incorporate these studies into their overall business strategy, especially if they are considering a large capital investment.
EDWARD D. MEYETTE, CPA, can be reached at (616) 752-4234 or [email protected].
