Cost segregation is a popular tax compliance strategy for realizing cash tax savings through reclassifying assets from long to short depreciation recovery periods. SourceHOV|Tax brings a full-range of fixed asset service offerings to help clients realize these tax savings. For taxpayers in the manufacturing industries, these offerings include identifying Other Tangible Property, “building” structures that can be reclassified to tangible personal property, and fixed asset reclassification studies. The case studies below illustrate these opportunities.
Case Study 1: In 2013, a heavy manufacturer built a $19 million fabrication facility including a craneway structure, land improvements, and associated machinery and equipment. SourceHOV|Tax was engaged to perform a cost segregation study. After reclassifying the craneway structure as seven-year tangible personal property and the associated land improvements to a 10-year recovery period, the taxpayer was able to recognize $10 million in additional first year depreciation deductions compared to treating the facility and its improvements as 39-year property. While reviewing the client’s fixed asset schedules as part of the cost segregation engagement, SourceHOV|Tax identified additional opportunities to reclassify existing fixed assets to shorter recovery periods or to use bonus depreciation. This review identified an additional $8 million taxpayer-favorable section 481(a) adjustment after scrubbing the fixed assets.
Case Study 2: In 2014, a heavy manufacturer acquired an existing $15 million manufacturing facility. SourceHOV|Tax was retained to provide a cost segregation study of the facility. By reclassifying heavy manufacturing craneway structures as tangible personal property in addition to regular cost segregation techniques, SourceHOV|Tax was able to reclassify 66 percent of the purchase price as land improvements or tangible personal property. This resulted in increased first year cash flow of approximately $500,000 and a Net Present Value benefit of approximately $1.8 million.
How is this possible?
Taxpayers in most manufacturing industries are assigned a seven-year tax recovery period for their tangible personal property. For each million dollars of basis, reclassifying a structure from 39-year nonresidential real estate to seven-year tangible personal property results in additional first-year tax deductions of approximately $550,000 after taking into account 50 percent bonus depreciation and the much shorter recovery period. Assuming a 40 percent tax rate, this means first year cash savings of approximately $220,000.
The former Investment Tax Credit (“ITC”) was a tax credit for the construction or acquisition of most tangible personal property and certain other tangible property, not including buildings and their structural components, used as an integral part of certain industries such as manufacturing. The former ITC rules still govern MACRS property classifications to a large extent. The meaning of the former ITC regulations and rules were frequently litigated. Over the course of many years, the courts developed tests to determine whether a structure was a building, other tangible property, or tangible personal property. Using these tests, SourceHOV|Tax is able to properly reclassify manufacturer facilities as buildings, land improvements, other tangible property, and even tangible personal property.
If your clients have heavy manufacturing facilities or automated facilities with minimal worker accommodations, please contact us to discuss a cost segregation study to determine whether the entire facility qualifies as short-life property.
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Keywords: cost segregation, manufacturing, craneway structure, automated facility, Charles Duncan