Originally published on Forbes.com.
The Tax Cuts and Jobs Act has radically changed the rules for bonus depreciation at least for a while. Instead of 50%, we will be getting 100%. And what is really exciting is that bonus depreciation will apply to used property. I’m thinking that there will be serious pressure to close deals before the end of the year, because this is one of the few provisions that is retroactive (to September 27, 2017).
An acquisition in 2018 will get the same treatment, but the top tax rate will be lower and more importantly, there will be a 20% deduction for flow-through income. By back of the envelope reckoning, a bonus depreciation acquisition of a million would save $395,000 if in service in 2017 and $296,000 if in service in 2018. For a corporation, it would be $350,000 versus $210,000.
What About Real Estate?
Now, this might not seem that exciting for real estate since buildings don’t qualify for bonus deprecation. But when you buy a building you are generally not just buying a building. There is land of course, which really stinks because you can’t depreciate it at all. But there is other stuff. Like the parking lot paving, landscape improvement, and cabinetry. Frankly, I am not that strong on the details, but it seems to generally work out to about 20% to 30% of the cost of a building being carved out as things that have a shorter class unlike the painfully slow forty years of the building (I know it is 39, but I use 40 for planning because the math is easier). And they qualify for bonus, which is now 100% and applies to used property thanks to our Christmas present from President Trump.
Cost Segregation
There is actually a kind of sub-specialty in the tax compliance and planning industry called cost segregation. The cost segregation industry, as far as I can tell consists of two types of people. There are the people who were smart enough to be engineers rather than accountants but realized there can be more money in high-level tax work than engineering. And then there are really good salesmen who scare accountants into recommending cost segregation studies to their clients at the risk of them hearing about it from some other accountant. The salesmen hands out these complicated looking spreadsheets that show the present value of accelerating the deductions. I don’t think the salesmen generally understand the math behind the illustrations, but they don’t really need to do their jobs.
Larger accounting firms will have their own cost segregation groups because it is something that can be “valued billed”. Value billing means getting money from clients out of proportion to the actual amount of work involved. Value billing is what corrupted the Big Four back in the nineties, but that is another story. I can’t however resist repeating my favorite observation that the main source of stress in public accounting is envy. The other thing to do is to get kickbacks from the cost segregation guys. Only you can’t call it a kickback
Do It Yourself?
I once had a client ask me why he couldn’t do the cost segregation himself. Like most real estate guys I know, he is kind of frugal resenting every dollar he spends particularly on people involved with clean work and no heavy lifting. The answer that the cost segregation guys pointed to me to is an IRS Market Segment Specialization Program training guide. Chapter 4 is Principal Elements of a Quality Cost Segregation Study and Report (QCSS) There are thirteen of them:
- 1. Preparation By An Individual With Expertise and Experience
- 2. Detailed Description Of The Methodology
- 3. Use of Appropriate Documentation
- 4. Interviews Conducted With Appropriate Parties
- 5. Use Of A Common Nomenclature
- 6. Use Of A Standard Numbering System
- 7. Explanation Of The Legal Analysis
- 8. Determination Of Unit Costs And Engineering “Take-Offs”
- 9. Organization Of Assets Into Lists Or Groups
- 10. Reconciliation Of Total Allocated Costs To Total Actual Costs
- 11. Explanation Of The Treatment Of Indirect Costs
- 12. Identification And Listing Of § 1245 Property
- 13. Consideration Of Related Aspects (e.g.I.R.C. § 263A, Change in Accounting Method And Sampling Techniques)
The implication is that if you don’t have that a revenue agent, sounding much like the soup nazi, will say “No cost seg for you” .
That’s not the way the tax law works. In the area of depreciation the last refuge of the scoundrel, the “Cohan rule” still applies. The Prime Directive of Reilly’s Laws Of Tax Planning – If you don’t have documentation at least have a plausible story – is based on the Cohan rule. A MSSP training guide is not authority. When the agent tells me that the back of the envelope computation cribbed from a “Quality Cost Segregation Study” of a similar building is not itself a QCSS, my answer is “How wrong could it be?”.
The cost segregation salesman will point out that my frugal client might miss something that the sharp engineer would have picked up, but that goes both ways, in the more likely event that there is no audit. At any rate, my unscientific conclusion was that it is worth paying five or ten grand on a QCSS for a deal over two million, but DIY might be OK below that.
Is This For Real?
I confirmed my reading of the bill with Lu Gauthier of the Boston Tax Institute, the best value provider of classroom-style continuing professional education in New England. Lu didn’t have much time for me as his phone is ringing off the hook and emails are flooding his in-box, while he combs through the Act for the umpteenth time.
Is It A Conspiracy?
The September 27 date had me a little mystified and being a cynical bastard I started combing through real estate news looking for a really big transaction in late September early October – ideally an acquisition by the Trump Organization. There is a more innocent explanation. The Unified Framework, a very rough sketch of what the Tax Cuts and Jobs Act would be, came out on September 27.
The Framework called for expensing of all depreciable assets acquired after September 27. Had that promised retro date not been included in the framework, a lot of deals would have been deferred which would not have made the economy look so good. And given that they wanted the bill as a Christmas present. September 27 would be about as late as the framework could be.
Terrible as I might think the act is as a citizen, I am now constrained by Reilly’s First Law of Tax Planning – It is what it is. Deal with it. And dealing with this one is going to be on the delightful side as I play the elf to President Trump’s Santa Claus.
The President mentions how the act will help jobs. I don’t know in general, but it will be more work for me and probably the cost segregation specialists. So thank you President Trump and Merry Christmas to you, which I now feel safe writing.
A Gotcha
Some deals might not get the favorable treatment due to a “binding contract” rule:
…property shall not be treated as acquired after the date on which a written binding contract is entered into for such acquisition.
Update
I heard from Kenneth Weissenberg, the Partner and Chair Real estate Services at EisnerAmper LLP, who confirms the opportunity this year.
The new tax law gives taxpayers three options for qualified property acquired after 9/27/17 and placed in service before the end of the year; 100% write off, 50% write off and depreciate the balance, or normal depreciation for the asset.
As a general rule we always recommend that our client get a cost segregation study when they acquire or build significant property or improvements. This year it is more important than ever. While the fast enactment of the legislation did not give taxpayers much time to act, those that already had projects in the works will certainly benefit from this provision. It should be noted that taxpayers who tried to take advantage of the enhanced write offs too soon may be out of luck. The 100% write off does not apply to property purchased pursuant to a binding contract entered into prior to 9/27/17.