Depreciation method study and cost segregation analysis
One potential tax planning opportunity to mitigate the effects of new IRC Section 174 requirement might be to analyze the depreciation methods for fixed assets. Until the TCJA changes to IRC Section 174, taxpayers with significant NOLs had little incentive to investigate tax deferral opportunities within the IRC Section 168 depreciation methods rules.
Crowe observation
With the capitalization of IRC Section 174 R&E costs requirement, taxpayers with significant NOLs might have more incentive to perform a depreciation method study or cost segregation analysis.
A depreciation method study involves analyzing the fixed-asset ledger to identify assets that were depreciated for federal tax purposes as long-lived property (such as 39 years) but that could have been classified under the modified accelerated cost recovery system (MACRS) asset classification as a shorter-lived property. In addition to reviewing the fixed-asset ledger, taxpayers can expect a typical depreciation method study to include a review of underlying contemporaneous documentation, such as invoice or purchase order detail, as well as interviews with informed representatives of the taxpayer with historical involvement in the underlying fixed assets.
For example, a taxpayer might treat assets such as parking lots, sidewalks, carpeting, data, and wiring as 39-year life property in their fixed-asset ledger. However, these assets can be depreciated over a five-, seven-, or 15-year life. Depending on the taxpayer’s facts and circumstances, the assets also might be eligible for the bonus depreciation deduction under IRC Section 168(k). Accordingly, reclassifying the assets to the appropriate MACRS asset classification could result in a significant benefit for the taxpayer.
A cost segregation analysis is another way to evaluate whether a taxpayer is entitled to additional depreciation deductions. A cost segregation analysis includes analyzing the costs of a newly acquired, constructed, or renovated facility and segregating those costs into their appropriate MACRS asset classifications for federal tax purposes. A cost segregation analysis involves a comprehensive methodology, including a review of invoice detail, discussions with informed representatives of the taxpayer, a detailed evaluation of construction documentation (such as construction drawings, construction contracts, bid documentation, subcontractor cost detail, and appraisals), and allocation of project indirect costs to their respective units of property.
Crowe observation
A cost segregation analysis could involve using professional construction cost estimating techniques to allocate the property to asset classes and often includes an in-person visit to the facility under study by the cost segregation professional.
If the taxpayer is eligible, misclassification in prior years can be fixed with an automatic change in accounting method and an IRC Section 481(a) adjustment. Amending a prior year tax return (or filing an administrative adjustment request in the case of a partnership subject to the centralized partnership audit regime) also might be an option if the assets being corrected have been depreciated only for that one year.
Looking ahead
The legislative landscape is still unclear. Although many are hoping for a repeal of the TCJA change to IRC Section 174, prospects for change seem dim, at least in the near future. Therefore, taxpayers should consider ways to mitigate the impact of these changes, including performing a depreciation method study or cost segregation analysis.
