I’d like to comment on the following article in the New York Real Estate Journal, “Cost segregation – wait a minute…Exercise caution and research all scenarios.”
This article addresses some of the pushback engineering based Cost Segregation professionals receive from accountants when approached about this tax planning strategy. I couldn’t agree more with the title of the article – but quite frankly, caution is just a best practice that should be exercised when considering any comprehensive tax planning for a client. A CPA’s decision should always be determined by what is in the best interest for the client and conclusions should be explained to their clients clearly.
For example, one of the pushbacks that we’ve heard from CPAs is, “Why should I have my client do a Cost Segregation Study now?” It’s going to give them a benefit now, but in a few years’ time they will have less of a depreciation deduction and all of a sudden they will have taxable income? Clients’ memories can be short; they don’t recall that they received a large benefit four or five years ago when they are showing taxable income.”
My response to that is Cost Segregation studies are built on a very basic principle known as the time value of money, this is the premise that a dollar today is worth more than a dollar in 39 years’ time. It is a basic principle that we, as tax planners, must take the time to explain to our clients. If we do an adequate job explaining it, remind them on an annual basis during tax preparation that this was completed, and reiterate what the benefit was in the previous year, then there should be less and less pushback from clients.
I often hear the point being made that “Our taxes are at the lowest rates that they will ever be. Shouldn’t we just wait until the tax rates increase in subsequent years when a deduction will be worth more because the tax rate will be higher?” My own crystal ball isn’t quite so clear. That could be the case, or it might not happen at all. If we have comprehensive corporate tax reform, which is being discussed by both the Democrats and the Republicans, maybe tax rates won’t be higher in the future. If this happens that means a lost tax planning opportunity for a client. Do you wait? Do you not wait? I don’t know. Predicting the future is simply not a CPA’s job. You plan and give advice based on what is happening now rather than what may or may not happen in the future.
It is also not necessarily true that qualified real estate professional tax status is needed to offset losses from one entity with income from another. Treasury Regulation 1.469-4 spells out how you can use real estate losses to offset regular trade or business income in very specific situations when there is identical ownership of the entities. Situations come up fairly frequently with many of our clients who have operating companies and a separate entity that owns the structure the company operates in. Losses can be identified through additional depreciation on the real estate entity and these losses can then be used to offset income from the operating entity that occupies that building. In other words, we could have a metal fabricating business entity whose building is owned by the same people (there must be common ownership between the two entities). In this case, we can use those two to offset one another.
Real estate losses can always be offset with real estate gains from other entities. However, there is an additional exception in the Treasury Regulations that offsets different types of income which the regulations generally prohibit. That regulation addresses what we call a “grouping election.” I’m discovering that only the very large firms understand grouping elections right now. Unfortunately, it effects even medium-sized and small practitioners like us, with clients who have ownership interests in buildings. I wish we could do something to broadcast this more widely because it is an incredibly useful tool that could lead to hundreds of millions of dollars in deductions.
One of the good points this article makes is that a building may be too old to take advantage of Cost Segregation. If a building was constructed or acquired prior to 1988 and no additional improvements were made to the property, then a property owner cannot take advantage of these benefits. That is why The Concord Group offers a no-cost feasibility study to our clients before we even embark on the process so the client/CPA has all the information to make an informed decision on whether or not this is the right tax planning strategy for their investment.
David J. Brown, CPA is the owner of KGR Brown and Associates P.C., a certified public accounting firm, whose concentration for the last 20 years has been in corporate, partnership and non-profit taxation. David is a member of the American Institute of Certified Public Accountants and the Illinois CPA Society. The firm has significant experience with cost segregation study principles and techniques.