Debunking the Myths
 
Written by: Steven D. Beaucaire, MST
Director - Tax | Bedford Cost Segregation, LLC

The present economic downturn has made everyone more than a little wary about the future. Many are hunkering down to take a wait-and-see approach, hoping to ride out a tough period. While it often seems the safest road in uncertain times, it is not always the wisest. As a cost segregation specialist, I have been amazed at the ever-growing list of reasons why not to do a cost segregation study (CSS). That is why it makes sense to address a few of the most common excuses given by both taxpayers and their advisors to postpone.

PASSIVE ACTIVITY MYTH DEBUNKED
Rental of real estate is deemed a passive activity by the IRS, and the gains and/or losses from the activity are passive as well. Without going into every detail, passive losses can only offset passive income; therefore, your depreciation is limited to the income from the passive activity. However, many of these situations are related party transactions with the operating company (the money maker) renting the property from its related real estate entity. Usually the rent is only high enough to cover the operating expenses of the real estate entity. In this situation, it is fairly easy to see that by raising the rent to approximate market level, one now has income to offset the increased losses because depreciation is accelerated as a result of a CSS. The net result leaves the operation company paying less tax due to the increased rent and the realty company, despite having increased income, is paying no taxes because of its increased depreciation. Could it get any better!

LIKE KIND EXCHANGE MYTH DEBUNKED
Like kind exchange was discussed in more detail in a recent article and pointed out how it can work not on the carry-over basis but on a step-up in basis. The basis of the old property must continue to be your basis for depreciation, hence the term carry-over basis. To review, the step-up is the subtraction of the selling price of the old property from the purchase price of the new property. Because the step-up is a new asset, performing a CSS on it will not endanger the §1031 transaction. Therefore, just as you have taken on higher expenses or are suffering a loss of income, a CSS can be the answer to increase cash flow through tax savings.

“NEXT YEAR WILL BE BETTER” MYTH DEBUNKED
There has been a new one on the scene since the 2008 election. Some have presumed that waiting until next year will be a better time to initiate a CSS because the tax rate is likely to go up and therefore yield a bigger benefit. The problem in making your decision contingent on future events is that those future events may never happen. It was recently leaked that contrary to popular opinion, the new administration may not increase taxes in 2009 or even in 2010. Then, too, what if revenues are raised not with increased tax rates but with the repeal of certain deductions? We have all heard the expression “no one’s pocketbook is safe while Congress is in session and it is only half safe when they’re not in session”. I believe that it is best to act now and get your deductions while they are still available. In 2008, you still have bonus depreciation, Qualified Leasehold Improvements (which qualify for bonus depreciation), and Qualified Restaurant Improvements (which also qualify for bonus depreciation).

“IT IS TOO LATE” MYTH DEBUNKED
It is never too late! First a CSS done in 2009 for your 2008 tax return is valid for you 2008 assets; the study does not have to be performed in 2008. Not only that, look-back studies can be performed on any prior year. The IRS has even included a section on look-back studies in their Audit Techniques Guide for Cost Segregation. You must file a change of accounting method (Form 3115), but it is an automatic change. That means if you qualify and fill out the form correctly, the method change is automatically accepted by the IRS. And an experienced cost segregation firm can guide you through the entire process.

After spending the last 33 years dealing with the tax law, I have come to the conclusion that this is not the time to fall victim to misguided information. Businesses will need every advantage to get through these uncertain times. No one knows how long it will take to turn the economy around, but if given the alternatives, initiating a cost segregation study is the proactive choice.