Applying Cost Segregation After Disposition
 
Written by: Steven D. Beaucaire, MST, CCSP
Director - Tax | Bedford Cost Segregation, LLC


Good news…it might be possible to recover tax dollars on sold properties. Revenue Procedure 2008-52 includes a provision that allows taxpayers to make a change in accounting method for assets after their disposition. As we close out another year and head into tax season you may want to consider cost segregation studies for any properties you, or your clients, sold in 2009. Where this strategy works, the benefits can be huge!

To make this approach work, the disposition and the change of accounting method must be in the same tax year (the year of change). The year of change is defined as the taxable year in which the item of depreciable or amortizable property was disposed of by the taxpayer. To do this one must be changing from an impermissible method of accounting to a permissible method for any depreciable or amortizable property subject to §§ 168, 197, 1400I, or 1400L(c), to former § 168, or to any additional first year depreciation deduction provision of the Code (for example, § 168(k), § 168(l), § 1400L(b), or § 1400N(d)). The assets must have been disposed of by the taxpayer during the year of change; for which the taxpayer did not take into account any depreciation allowance, or they took less than the depreciation allowable in the year of change or any prior taxable year.

A taxpayer making this change must attach the original signed Form 3115 to their timely filed federal tax return for the year of change and must file a second signed copy with the IRS National Office no later than when the original Form 3115 is filed with the federal tax return for the year of change. The § 481(a) adjustment, which is the difference in depreciation before and after the cost segregation study, must be taken into account in the year of change.

While this approach can produce significant benefits, determining whether is makes sense may not be so clear. This is because the taxpayer must make adjustments to the calculation of gain or loss and recapture caused by the change in accounting method. At this point one might think it’s a wash, because any gain in depreciation deductions, would be offset by taxes from recapture. However, the depreciation recapture rules under § 1245 and § 1250 state that recapture is required only to the lesser of the gain or the depreciation taken. Therefore, if you have no gain, you have no recapture. In today’s economic environment more and more taxpayers may be selling properties where there is no taxable gain, in which case this strategy may provide tremendous financial benefit.

To get a better feel for the potential results, let’s look at some numbers. The examples below illustrate the impact of applying a look-back study (retroactive cost segregation study), after sale. The calculations assume the study allocated 75% to 39-year, 10% to 15-year, and 15% to five-year for a property that was being depreciated 100% at 39-years. The calculations also assume a 40% effective tax rate for § 1245 recapture, 30% for § 1250 recapture, and 20% for capital gains.

Subject Property Facts:
 
• Cost Basis: $5,000,000
 
• Placed in service: 1/1/2005
 
• Sold: 6/1/2009


Scenario #1:
 
If the property was sold for $6,000,000 and the results of the CSS applied to the 2009 tax return as required by 2008-52, the taxpayer would realize a benefit of $277,765 from the increased depreciation. However, this savings would be offset by an increased recapture tax of $276,291. The net benefit in this case would be $974; obviously not worth doing a study.

Scenario #2:
 
If the property was sold for $3,700,000, or any amount less than the adjusted basis, then there is no gain and therefore no recapture tax. In this scenario, the taxpayer is able to get the full benefit of $277,765.

The ability to file a change in accounting method after sale has created yet another application for a cost segregation study. As illustrated above, in situations where this strategy works the benefits can be huge.

As always, be sure to consult with your tax advisor and a qualified cost segregation expert, preferably a Certified Cost Segregation Professional (CCSP) as recognized by the American Society of Cost Segregation Professionals (ASCSP), before making any decisions.