Most business fixed assets are depreciated over five or seven year lives. The cost of buildings, in contrast, has to be recovered over much longer lives — 27.5 for residential property and 39 years for other business buildings. An entire “cost segregation study” industry thrives by identifying items to carve out of buildings as shorter-lived assets.
An apartment building, or a finely-crafted machine?
Cost segregation studies are most effective in a factory building, where special wiring, concrete pads built to accommodate heavy machinery, lighting and so on can qualify for shorter lives. There is less opportunity for savings in apartment buildings, but that didn’t keep one partnership that showed up in Tax Court this week from giving it the old college try. Amerisouth XXXII, Ltd. threw in everything — including the kitchen sink — as shorter-lived property to maximize depreciation deductions. Judge Holmes sets the stage in his distinct style:
The Commissioner argues that with minor exceptions the apartment complex is one asset that AmeriSouth must depreciate over 27.5 years. AmeriSouth argues that, whatever the apartment complex may look like to an untrained observer, to a tax adept it is not a single asset but a collection of more than 1,000 components depreciable over much shorter periods. It is usually the case that a shorter depreciation period benefits taxpayers. It would certainly benefit AmeriSouth by generating hundreds of thousands of dollars’ worth of accelerated depreciation deductions. We are tempted to say this is why AmeriSouth throws in everything but the kitchen sink to support its argument — except it actually throws in a few hundred kitchen sinks, urging us to classify them as “special plumbing,” depreciable over a much shorter period than apartment buildings.
Judge Holmes considers the sinks:
AmeriSouth concentrates most of its persuasive efforts on the permanence of the sinks. AmeriSouth argues that the sinks are easy to remove — disconnect the sink from the water lines and remove approximately four screws or clamps — and uses the 2003 apartment renovations as an example.
But section 1.48-1(e)(2), Income Tax Regs., specifically lists sinks as structural components (“‘structural components’ includes * * * plumbing fixtures, such as sinks and bathtubs”). And while AmeriSouth tags this type of plumbing with the epithet “special”, providing water for the kitchen is hardly unusual in the sense of Scott and later cases, and AmeriSouth fails to give any other evidence that it periodically replaced or even planned to replace sinks after the 2003 renovation. So we find the sinks are also structural components of the buildings and not depreciable apart from them.
This reminds me of the “sledgehammer theory” used back in the old investment tax credit days — in fact, cost segregation studies are pretty much the old ITC studies under a different name. The theory was that if it could be moved with the help of a sledgehammer, it was “movable,” rather than part of the building, and could qualify for the credit. It wasn’t a particularly successful theory.
In this case, many other items – pipes, drain lines, wiring, and electric panels, for example, were claimed to be five-year property, unsuccessfully. A few items — garbage disposals, special plugs for refrigerators, and cable, phone and data outlets — did qualify for shorter lives.
The Moral: You should ponder what you are buying if you buy real property; there may be more depreciation available than meets the eye. But don’t throw in the kitchen sink.
Anthony Nitti has more.
Cite: AmeriSouth XXXII Ltd, T.C. Memo 2012-67