Just for a quick review, cost segregation studies are reports put together by structural engineers and tax accounts to reclassify components of section 1250 real property into personal property. In doing so, owners in real estate can depreciate the segregated components over a shorter period (5, 7 or 15 years) as opposed to 27.5 years for residential and 39 years for commercial. The result can be huge tax savings over a short period of time.
Prior case-law has determined that if a component falls into one of the following three categories, taking into account all of the facts, than it can be segregated and depreciated as personal property.
1. Accessory to a business – courts have determined when property arguably serves a function specific to a taxpayer’s business or an item that specifically serves a piece of equipment is not serving the building in which that equipment is placed and is thus considered personal property.
2. Permanence – the following factors determine whether or not property is permanent
-whether the property is capable of being moved and whether it had in fact been moved;
-Whether the property is designed or constructed to remain permanently in place;
-whether there are circumstances which tend to show that the property may or will have to be moved;
-whether removal of the property would be a substantial and time-consuming job;
-the damage the property would sustain upon removal; and
-the manner of “affixation” of the property to the land.
3. Ornamentation – tangible personal property includes special lighting, false balconies and other exterior ornamentation that have no more than an incidental relationship to the operation or maintenance of a building.
A recent Tax Court decision (TC Memo 2012-67) puts the kabosh on many items that had been typically segregated. If nothing else, the one thing that we should take from this case is how the Court defined a building’s “shell”. When looking at the purpose of a particular item, do we look at the items relation to a generic shell building or do we look at it in relation to the specific kind of building it is (whether it is an apartment building, commercial manufacturing, hotel, or office space). The Court decided that you look to the operation or maintenance of the specific type of building, in this case, an apartment building.
The following is a list of items that had been typically segregated as tangible personal property, but in this case were considered structural components.
-Sinks and piping
-General use outlets
Are cost segregation studies dead? Not necessarily. In fact this case confirms the legality of them. But, especially in the case of apartment buildings, this case does limit their effectiveness by reducing the number of components that can be segregated as tangible personal property.