Cost-segregation studies and the impact of the tangible property regulations.

• Author: Abdoo, Kate

With the recovering economy and the tangible property regulations (T.D. 9689 and T.D. 9636, the "final regulations") on so many businesses' minds, many taxpayers are taking advantage of cost-segregation studies for their building properties. Cost-segregation studies have long provided benefits to taxpayers by segregating shorter-lived personal property (e.g., carpet or other personal property) from longer-lived real property.

In addition to generally providing results favorable to taxpayers by accelerating depreciation deductions on the segregated property (including identifying property that may be eligible for bonus depreciation), these studies can help to break out the cost of components of building property, which can assist taxpayers in determining the remaining basis of disposed portions of building assets. Although these studies are nothing new, certain rules in the final regulations, when compared to the previous regulations, as well as certain nuances of the transition guidance issued to assist taxpayers in adopting the regulations, may have a surprising effect on how cost-segregation studies are conducted.

This item highlights several important aspects of the final regulations and related transition guidance that may affect cost-segregation studies and resulting changes in accounting methods. Readers should be aware that this item is intended to provide only a high-level discussion of certain aspects of federal income tax law as the law applies to cost-segregation studies. This item also focuses solely on assets excluded from general asset accounts because assets included in general asset accounts may be subject to different rules for dispositions (see Regs. Sec. 1.168(i)-1 for rules that apply to general asset accounts). (For more on the regulations, see "What Taxpayers Need to Know to Comply With the Final Tangible Property Regulations," p. 266.)

Potential Impact 1: Partial Dispositions and Remaining Adjusted Basis

As with the law before the final regulations were issued, if a taxpayer disposes of an asset (e.g., through abandonment), the taxpayer must recognize the disposition for federal income tax purposes in the

year the disposition occurs. Thus, asset dispositions generally result in taxpayers' being unable to continue to depreciate the remaining basis of the disposed asset after the disposition occurs. The final regulations provide rules for defining "assets" for disposition purposes and generally provide that an asset is determined based on the facts and circumstances of each disposition (Regs. Sec. 1.168(i)-8(c)(4) (i)). However, the final regulations contain special rules for building property, providing specifically that each building (including its structural components) is the asset (Regs. Sec. 1.168(i)-8(c)(4) (ii) (A)). Further, the final regulations consider any subsequent improvement or addition as a separate asset (Regs. Sec. 1.168(i)-8(c)(4)(ii)(D)).

The final regulations permit an election to recognize partial dispositions of assets. In this case, taxpayers may elect to recognize abandonments of portions of assets (e.g., structural components of a building) (Regs. Sec. 1.168(i)-8(d) (2)). If a taxpayer makes the election, in the case of a physical abandonment, the taxpayer recognizes a loss in the amount of the adjusted depreciable basis of the portion of the asset at the time of abandonment (Regs. Sec. 1.168(i)-8(e)(2)). Thus, a partial-disposition election can be very favorable to taxpayers. However, taxpayers that elect to recognize a partial disposition will have to capitalize the expenditure for the replacement portion even if the expenditure would normally be a deductible repair.

While the partial-disposition election generally provides a benefit to taxpayers undergoing improvements, the mechanism...