Cost Segregation Audit Techniques Guide

Publication 5653 (6-2022) Catalog Number 20884M Department of the Treasury Internal Revenue Service www.irs.gov

Cost Segregation Audit

Technique Guide

This document is not an official pronouncement of the law or the position of the Service and cannot be used,

cited, or relied upon as such. This guide is current through the revision date. Since changes may have

occurred after the revision date that would affect the accuracy of this document, no guarantees are made

concerning the technical accuracy after the revision date.

The taxpayer names and addresses shown in this publication are hypothetical.

Audit Technique Guide Revision Date: 6/1/2022

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Table of Contents

Chapter 1 – Introduction ................................................................................ 1

A. Preface ........................................................................................................ 1

B. Purpose of the Cost Segregation Audit Techniques Guide ......................... 1

C. Background .................................................................................................. 1

D. Summary and Conclusions .......................................................................... 3

Chapter 2 – Legal Framework ....................................................................... 4

A. Overview ...................................................................................................... 4

B. Early History of Depreciation ....................................................................... 4

C. Bulletin F ...................................................................................................... 5

D. Codification of Depreciation Changes ......................................................... 6

E. Guideline Life System .................................................................................. 6

F. Asset Depreciation Range (ADR) System ................................................... 7

G. Accelerated Cost Recovery System ............................................................ 7

H. Modified Accelerated Cost Recovery System .............................................. 8

I. Section 1245 and 1250 Property ................................................................... 9

J. Investment Tax Credit - § 48 ...................................................................... 10

K. Tests for Distinguishing § 1245 and § 1250 Property ................................ 12

L. Inherently Permanent Test ......................................................................... 12

M. Hospital Corporation of America Case ...................................................... 14

N. Electrical Distribution Systems .................................................................. 14

O. Incentives for Cost Segregation and Cost Recovery ................................. 15

P. Audit Guidance .......................................................................................... 16

Q. Summary ................................................................................................... 16

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Chapter 3 – Cost Segration Approaches ................................................... 17

A. Introduction ................................................................................................ 17

B. What are the Most Common Approaches Utilized for Cost Segregation

Studies? ......................................................................................................... 18

C. What are the Attributes of the Various Cost Segregation Approaches? .... 18

D. What Approach is Required by the IRS? ................................................... 22

E. Summary and Conclusions ........................................................................ 22

Chapter 4 – Principal Elements of a Quality Cost Segregation Study and

Report ........................................................................................................... 24

A. Introduction ................................................................................................ 24

B. What is a “Quality” Cost Segregation Study? ............................................ 24

C. Principal Elements of a Quality Cost Segregation Study ........................... 24

D. Principal Elements of a Quality Cost Segregation Report ......................... 31

E. Summary and Conclusions ........................................................................ 32

Chapter 5 – Review and Examination of a Cost Segregation Study ....... 34

A. Introduction ................................................................................................ 34

B. Steps for Examining a Cost Segregation Study and Report ...................... 34

1. Initial Risk Analysis .................................................................................... 34

2. Examination................................................................................................ 38

3. Other Considerations ................................................................................. 44

C.Summary and Conclusions ......................................................................... 56

Chapter 6 Special Topics ............................................................................ 57

A. Uniform Capitalization ................................................................................ 57

1. Introduction ................................................................................................ 57

2. Application of the Capitalization Rules Under § 263A ................................ 57

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3. Capitalization of Costs Under § 263A .................................................... 57

4. Capitalization of Interest Under § 263A(f) .............................................. 59

B. Change in Accounting Method ................................................................... 61

1. Introduction ................................................................................................ 61

2. Historical Service Position .......................................................................... 61

3. Change in Litigating Position ...................................................................... 63

4. Peco Foods Case....................................................................................... 63

5. Tangible Regulations – Treas. Reg. §§§ 1.263(a)-1, -2, -3 ........................ 64

6. Revenue Procedures Involving Method Changes ...................................... 64

7. Summary .................................................................................................... 65

C. Depreciation Overview ............................................................................... 66

1. Introduction ................................................................................................ 66

2. MACRS ...................................................................................................... 66

3. Depreciation Periods and Conventions ...................................................... 67

4. Recovery Periods ....................................................................................... 68

5. Class Lives ................................................................................................. 70

6. Revenue Procedure 87-56 ......................................................................... 71

7. Examples ................................................................................................... 72

8. Additional References……………………………………………………….…73

Relevant Court Cases ................................................................................ 74

1. Introduction ................................................................................................ 74

2. Arrangement of Information ....................................................................... 74

3. Table 1: Case Law by Case Name (Reverse Chronological Order) ......... 75

4. Table 2: Case Law by CSI MasterFormat Divisions (2004 and 1995) ...... 84

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5. Table 3: Listing of CSI MasterFormat Divisions (2004 and 1995) ............. 94

6 MASTERFORMAT 1995 EDITION ............................................................. 95

E. Inherently Permanent Standard ................................................................. 96

1. Introduction ................................................................................................ 96

2. Inherently Permanent Standard Under § 168 ............................................ 96

3. Inherently Permanent Standard Under § 263A .......................................... 99

4. Comparison of Inherently Permanent Standard Under §§ 168 and 263A .. 99

5. Inherently Permanent Standard Under § 199 .......................................... 102

6. Comparison of Inherently Permanent Standard Under §§ 168 and 199 .. 103

7. Conclusion ............................................................................................... 105

F. Construction Process ............................................................................... 105

1. Introduction .............................................................................................. 105

2. Stages in the Construction Process ......................................................... 105

3. Other Project Delivery Methods ............................................................... 119

G. Information Document Requests ............................................................. 119

1. Introduction .............................................................................................. 119

2. IDR G.1 Purpose – To Identify the Participants and their Respective Roles

in the Preparation of a Cost Segregation Study/Analysis ............................ 120

3. IDR G.2 Purpose – not Identify the Specific Properties Subject to Cost

Segregation Study/Analysis ......................................................................... 120

4. IDR G.3 Purpose – To Locate the Source of Property Blueprints and

Drawings ...................................................................................................... 120

5. IDR G.4 Purpose – To Obtain a Copy of the Cost Segregation Study ..... 120

6. IDR G.5 Purpose – To Obtain a Copy of the Study Computations and

Formula ........................................................................................................ 120

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7. IDR G.6 Purpose – To Ask Specific Questions about Segregated

Properties ..................................................................................................... 121

8. IDR G.7 Purpose – Request for Specific Items and Amounts .................. 122

H. IRC §§ 179, 179D, and Bonus Depreciation ............................................ 123

1. Recent Law .............................................................................................. 123

2. IRC § 179 Deduction ................................................................................ 123

3. IRC § 179D Deduction… ……………………………………………………. 124

4. Bonus Depreciation – In General ............................................................. 125

5. Acquisition Requirements and Placed in Service Dates .......................... 129

6. Bonus Depreciation Rates After 9/27/2017 .............................................. 131

7. Acquisition Requirement – In General ..................................................... 132

8. Chief Counsel Guidance on the Application of Bonus Depreciation

Regulations to a Cost Segregation Study – FAA 20140202F ...................... 135

9. Method of Accounting Issues Related to Bonus Depreciation ................. 137

10. Election Out of Bonus Depreciation ....................................................... 139

Chapter 7 Industry Specific Guidance ..................................................... 140

A. Casinos .................................................................................................... 141

B. Restaurants.............................................................................................. 153

C. Retail Industries ....................................................................................... 164

D. Pharmaceutical and Biotechnology ......................................................... 175

E. Auto Dealership Industry .......................................................................... 190

F. Auto Manufacturing Industry .................................................................... 205

Chapter 8 Issue Specific Guidace ............................................................ 240

A. Electrical Distribution System .................................................................. 240

1. Introduction .............................................................................................. 240

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2. Definitions and Building Electrical System Illustration .............................. 240

3. Legal Background .................................................................................... 242

4. Functional Allocation – Illustration ............................................................ 244

5. Summary .................................................................................................. 251

B. Stand-Alone Open-Air Parking Structures ............................................... 252

1. Introduction .............................................................................................. 252

2. Description of Stand-Alone Open-Air Parking Structures ........................ 252

3. Applicable Tax Law .................................................................................. 253

4. Parties Positions ...................................................................................... 254

5. Analysis .................................................................................................... 255

6. Penalty ..................................................................................................... 257

7. Summary .................................................................................................. 261

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Chapter 1 – Introduction

Preface

The 2022 update of the Cost Segregation Audit Technique Guide was accomplished

through collaboration led by the Deductible & Capital Expenditures Practice Network (DCE

PN), the Methods of Accounting and Timing (MAT) Practice Network, and the Inventory &

263A Practice Network. Updates were necessitated due to changes in the tax law from the

passage of the Protecting Americans from Tax Hikes (PATH) Act - P.L. 114-113, the Tax

Cuts and Jobs Act (TCJA) – P.L. 115-97, the Coronavirus Aid, Relief, and Economic

Security (CARES) Act – P.L. 116-136, and the Taxpayer Certainty and Disaster Tax Relief

Act of 2020, enacted as Division EE of the Consolidated Appropriations Act, 2021 - P.L.

116-260. Topics updated include § 263A, Change of Accounting Method, Depreciation,

Bonus Depreciation, § 179 deduction, § 179D deduction, and Qualified Improvement

Property (QIP).

Purpose of the Cost Segregation Audit Techniques Guide

This Audit Techniques Guide (ATG) has been developed to assist Internal Revenue

Service (Service) examiners in the review and examination of cost segregation studies. The

primary goals are to provide examiners with an understanding of:

• Why cost segregation studies are performed for Federal income tax purposes;

• How cost segregation studies are prepared;

• What to look for in the review and examination of these studies; and,

• When certain issues identified in the cost segregation study need further

examination.

The ATG was originally developed by a cross-functional team of Service Engineers and

Revenue Agents. It was updated by members of the DCE PN and is not intended as an

official IRS pronouncement. Accordingly, it may not be cited as authority.

Background

To calculate depreciation for Federal income tax purposes, taxpayers must use the correct

method and proper recovery period for each asset or property owned. Property, whether

acquired or constructed, often consists of numerous asset types with different recovery

periods. Property is typically separated into individual components or asset groups having

the same recovery periods and placed-in-service dates to properly compute depreciation.

When the actual cost of each individual component is available, this procedure is simple.

When only lump-sum costs are available, however, cost estimating techniques may be

required to "segregate" or "allocate" costs to individual components of property (e.g., land,

land improvements, buildings, equipment, furniture and fixtures, etc.). This type of analysis

is generally called a "cost segregation study," "cost segregation analysis," or "cost

allocation study."

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An increasing number of taxpayers have submitted either original tax returns or claims for

refund with depreciation deductions based on cost segregation studies. The underlying

incentive for preparing these studies for Federal income tax purposes is the significant tax

benefits derived from using shorter recovery periods and accelerated depreciation methods

(including bonus depreciation and Internal Revenue Code (IRC) § 179 deduction) for

computing depreciation deductions. Examiners need to understand both the rationale used

to segregate property into its various components, and the methods used to allocate the

total project costs among these components.

Cost segregation studies are most commonly prepared for the allocation or reallocation of

building costs to tangible personal property. A building, termed "§ 1250 property", is

generally non-residential real property (39-year) or residential rental property (27.5-year)

property eligible for straight-line depreciation. Equipment, furniture, and fixtures, termed "§

1245 property", are tangible personal property. Tangible personal property has a shorter

recovery period (e.g., 5 or 7 years) and is also eligible for accelerated depreciation (e.g.,

double declining balance, bonus depreciation and § 179 deduction). Therefore, a faster

depreciation write-off (and tax benefit) can be obtained by allocating property costs to §

1245 property.

The following example illustrates the tax benefits of a cost segregation study. In general, a

turnkey construction project includes elements of tangible personal property (e.g., phone

system, computer system, process piping, storage tanks, etc.). It is relatively easy to

identify these items as § 1245 property and allocate a portion of the total project costs to

them. A taxpayer’s cost segregation study might also report certain building occupancy

items (e.g., carpeting, wall coverings, partitions, millwork, lighting fixtures) as § 1245

property that likely would have been classified or grouped under § 1250 property without

the completion of a cost segregation study. These items may or may not constitute as

qualifying § 1245 property depending on the particular facts and circumstances for which

the project was designed.

This next example illustrates the complexity of cost segregation issues. In addition to

identifying specific project components that qualify as § 1245 property, cost segregation

studies may treat portions of building components as § 1245 property. For example, some

items of the building’s electrical system support both § 1245 property and § 1250 property.

The Study will typically identify the costs of the branch circuits feeding the § 1245 property

and classify according to the recovery period of the § 1245 property (i.e., 5 or 7-year

recovery). It may also identify that, for example, 15 percent of a building’s electrical

distribution system (EDS) directly supports § 1245 property, such as specialized kitchen

equipment. Based on that conclusion, the study will then treat 15 percent of the EDS cost

as § 1245 property along with the identified § 1245 branch circuits. See Chapter 8.A -

Functional Allocation of a Buildings Electrical Distribution System for further details. The

allocation of building components to § 1245 property is often a contentious issue.

Property allocations and reallocations are typically based on criteria established under the

Investment Tax Credit (ITC) laws under § 48. Complex and often conflicting guidance

relating to property qualifying for ITC, resulting from numerous legislative acts, court

decisions and Service rulings, and a lack of bright-line tests, have impacted the ease of

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distinguishing § 1245 property from § 1250 property. Related issues, such as the

capitalization of interest and production costs under IRC § 263A and changes in accounting

method, add to the complexity of this issue. For additional guidance on court rulings refer to

Chapter 6.D - Relevant Court Cases included in this ATG.

In a landmark decision, the Tax Court ruled that, to the extent tangible personal property is

included in an acquisition or in overall costs, it should be treated as such for depreciation

purposes. The court also decided that the rules for determining whether property qualifies

as tangible personal property for purposes of ITC (under pre-1981 tax law) are also

applicable to determining depreciation under current law. See, Hospital Corporation of

America, 109 T.C. 21 (1997). The Service acquiesced to the use of ITC rules for

distinguishing § 1245 property from § 1250 property.

This ATG provides technical information, audit techniques and examples of proper cost

segregation studies to focus the efforts of examiners. The use of cost segregation studies

will likely continue to increase, and there are currently no standards regarding the

preparation of these studies. These studies vary widely in terms of the methodology,

documentation, depth, format, and expertise of the study’s preparer. This lack of

consistency, coupled with the complexity of the law in this area, often results in an

examination that can be controversial and burdensome for all parties.

Examiners reviewing cost segregation studies must determine the proper classification and

correct costs of property. In some cases (e.g., small projects) examiners may be able to

evaluate a study without assistance. However, other studies may require specialists with

expertise, industry experience, and specialized training (e.g., Engineers, Computer Audit

Specialists and/or DCE PN Senior Engineers and Revenue Agents). Examiners should

perform a risk analysis as early as possible to determine the depth of an examination and

the need for additional assistance.

Technical and/or procedural cost segregation questions may be submitted to the DCE PN.

Summary and Conclusions

Depreciation issues involving cost segregation studies cross all Large Business and

International (LB&I) industry lines and impact Small Business and Self Employed (SB/SE)

taxpayers as well. The lack of consistency in cost segregation studies and the absence of

bright-line tests for distinguishing property contribute to the difficulties of this issue. The

purpose of this ATG is to provide the foundation to a better understanding of cost

segregation studies and to provide the examination steps that will facilitate the audit

process and minimize burden on taxpayers, practitioners, and Service examiners alike.

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Chapter 2 – Legal Framework

A. Overview

To better understand tax controversy surrounding the use of cost segregation studies; it is

important to review the relevant legal history and the motivations of taxpayers to allocate

costs to personal property. The legislative and judicial history of asset classification,

depreciation, and Investment Tax Credit (ITC) are closely related. Accordingly, much of the

discussion will focus on the rules and decisions impacting several interrelated Code

sections (including ITC that was revoked in 1986).

The Internal Revenue Code (IRC) has historically authorized depreciation deductions as an

allowance for the exhaustion, wear and tear, and obsolescence of property used in a trade

or business or for the production of income (§ 167 and the regulations thereunder). The

deduction has generally been calculated with respect to the adjusted basis and useful life

(or recovery period) of the property by utilizing an appropriate depreciation method. At one

time, salvage value was also a factor in the computation. Buildings and structural

components have substantially longer depreciable lives than tangible personal property.

The shorter the useful life (or recovery period) of any given property will result in a larger

annual tax deduction to the taxpayer. Therefore, it is desirable for taxpayers to maximize

costs allocable to tangible personal property to accelerate depreciation deductions and

reduce tax liability. This chapter provides a brief historical perspective of the statutes,

regulations and major court cases that relate to cost segregation studies.

B. Early History of Depreciation

For about 20 years after the introduction of our present income tax system in 1913,

taxpayers were generally given freedom to determine depreciation allowances. Both

individuals and corporations could claim a reasonable allowance for depreciation of

property arising out of its use or employment in the business or trade. The deductions

claimed were not challenged unless it could be shown by clear and convincing evidence

that they were unreasonable. Prior to 1934, a taxpayer had wide leeway as to the amount

which could be written off each year against current income as an allowance for the cost of

machinery, equipment, and buildings. As long as the taxpayer’s policy was consistent and

in accordance with sound accounting practice, the tax authorities raised little question,

realizing that the cost could be written off only once. See Announcement 71-76, 1971-2

C.B. 503.

In 1934, the Treasury Regulations (Treas. Reg.) were amended to provide that the burden

of proof would rest upon the taxpayer to sustain the depreciation deduction claimed.

Taxpayers became responsible to furnish full and complete information with respect to the

cost or other basis of the assets related to the claimed depreciation. The required

information for each asset included the age, condition and remaining useful life, the portion

of their cost or other basis, which had been recovered through depreciation allowances for

prior taxable years, and any other information as the Commissioner may require in

substantiation of the deduction claimed. Whatever plan or method of depreciation a

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taxpayer would choose to adopt, it “must be reasonable and must have due regard to

operating conditions during the taxable period.” T.D. 4422, 1934-1 C.B. 58.

C. Bulletin F

The earliest edition of Bulletin “F” was a pamphlet issued in 1920, which contained no

schedule of suggested average lives, but defined depreciation as follows: “Depreciation

means the gradual reduction in the value of property due to physical deterioration,

exhaustion, wear, and tear through use in trade or business.” Obsolescence was treated as

a separate and supplemental factor in computing the depreciation allowance where the

facts supported an additional amount. Bulletin “F” was first revised in 1931, at which time

the first schedule of suggested lives was published as a separate pamphlet. The schedule

provided useful lives for individual assets used by industry groups. In Bulletin “F”, the

Internal Revenue Service (Service) explicitly frowned on the use of a composite rate of

depreciation; rather, the Service advocated depreciation by items or by groups of items

having practically identical physical characteristics and length of life. In conjunction with the

burden shifting from the Service to the taxpayer regarding depreciation deductions, useful

life became largely determined by reference to standardized lives prescribed in Bulletin “F”

and a taxpayer had a heavy burden of proof to sustain any shorter life for an individual

asset.

Bulletin “F" underwent a second revision in 1942 and provided a useful life guide for various

types of property based on the nature of a taxpayer's business or industry. Bulletin “F”

identified over 5,000 assets used in 57 different industries and activities and described two

procedures for computing depreciation for buildings:

1. Composite Method: A depreciation chart provided a composite rate for 14 different

types of buildings, including all installed building equipment. The recommended

rates ranged from 1.5% per year for good quality warehouses and grain elevators to

3.5% per year for lesser quality theaters. These composite depreciation rates

correspond to useful lives ranging from 28.5 years to 66.7 years.

2. Component Method: Taxpayers could elect to depreciate building equipment

separately from the structure. A list provided lives for various types of structures,

ranging from 50 years for apartments, hotels, and theaters, to 75 years for

warehouses and grain elevators. A separate list provided lives for over 100 items of

installed building equipment, ranging from 5 to 25 years, with certain installed

building equipment listed as having the same life as the life of the building in which it

was installed.

Bulletin “F” also allowed taxpayers to either depreciate individual items on a separate basis

or to combine assets into composite, classified, or group accounts and depreciate the

group account as a single asset. Historically, some taxpayers have interpreted this to mean

that assets can be segregated into components and depreciated separately.

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D. Codification of Depreciation Changes

In 1954, major changes were made to depreciation laws. Aside from the authorization of

new methods of depreciation, § 167(d) was added which authorized written agreements

between the Service and taxpayers specifically dealing with the useful life and rate of

depreciation of any property.

In 1956, the ability to depreciate on an account basis (first allowed in Bulletin “F”) was

codified in Treas. Reg. § 1.167(a)-7(a). The regulations moved away from the concept of

physical life, focusing instead on the period of time the property was used in the trade or

business of the taxpayer. See Treas. Reg. § 1.167(a)-1(a). Also, as part of a policy

designed to reduce administrative controversies, the Service codified a policy that it would

only re-determine estimated useful life when the change in the useful life is significant and

there is a clear and convincing basis for the redetermination. See Treas. Reg. § 1.167(a)-

1(b).

In Shainberg vs. Commissioner, 33 T.C. 241 (1959), the Service challenged the taxpayer’s

method of depreciation of segregating buildings and the various items of equipment in the

buildings into separate component groups. The Tax Court held that the taxpayer could

calculate depreciation using a component grouping method as was their right under the

regulations. In general, the courts have sustained the estimated useful lives assigned by

taxpayers such as a 40-year life for the building structure, a 15-year life for the roofs,

plumbing, wiring and elevators, and a 10-year life for the paving, ceilings, and heating and

air conditioning systems.

E. Guideline Life System

Revenue Procedure (Rev. Proc.) 62-21, 1962-2 C.B. 418, superseded Bulletin “F”. Instead

of thousands of asset classifications, assets were grouped into approximately 75 broad

industrial classifications and by certain broad general asset classifications, with a

“Guideline Life” established for each of these classes. The guideline lives were about 30-40

percent shorter than Bulletin “F” lives and about 15 percent shorter than the lives in actual

use by taxpayers. Use of the guideline lives required taxpayers to meet a reserve ratio test

(complex provision). The Rev. Proc. represented a fundamental change by treating assets

as a class rather than as individual assets; even though assets within a class were

heterogeneous with respect to ages, useful lives, and physical characteristics. The asset

class for buildings included "the structural shell of the building and all integral parts

thereof", as well as “equipment which services normal heating, plumbing, air conditioning,

fire prevention and power requirements, and equipment such as elevators and escalators.”

The Rev. Proc. listed 13 different types of buildings, with guideline lives ranging from 40

years for apartments, hotels, and theaters, to 60 years for warehouses and grain elevators.

The Guideline Life system did not address repair and maintenance expenditures.

Revenue Ruling (Rev. Rul.) 66-111, 1966-1 C.B. 46, addressed the use of component

depreciation for used real property and distinguished its facts from those in Shainberg, Rev.

Rul. 66-111 decided that "when a used building is acquired for a lump sum consideration,

separate components are not bought; a unified structure is purchased” such that the value

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of components (e.g., ceilings, floors, electrical systems, etc.) of a used building cannot be

separated from the value of the building as a whole. Thus, the cost basis of used real

property cannot be allocated into separate component accounts for determining a

composite life in computing depreciation; rather, an overall useful life for the building must

be determined based upon the building as a whole. The ruling was later modified by Rev.

Rul. 73-410, 1973-2 C.B. 53, which held that the component method of computing

depreciation may be utilized for used real property if: 1) the cost of acquisition is properly

allocated to the various components based on their value; and 2) useful lives are assigned

to the component accounts based on the condition of such components at the time of

acquisition. See also Lesser v. Commissioner, 352 F.2d 789 (9

Cir. 1965).

Rev. Rul. 68-4, 1968-1 C.B. 77, concluded that “it is not proper to use the component

method of computing depreciation by assigning the guideline class life from Rev. Proc. 62-

21 to the structural shell of a building and assign different useful lives to the other integral

parts or components of the building. Rev. Proc. 62-21 may only be used where all the

assets of the guideline class (building shell and its components) are included in the same

guideline class for which one overall composite life is used for computing depreciation."

F. Asset Depreciation Range (ADR) System

Rev. Proc. 72-10, 1972-1 C. B. 721, superseded Rev. Proc. 62-21 and set forth the Class

Life Asset Depreciation Range (ADR) system for tangible assets placed in service after

1970. The purpose of the ADR system was to minimize controversies about useful life,

salvage value, and repair and maintenance expenditures. It also abolished the

controversial reserve ratio test. Under the elective ADR system, all tangible assets were

grouped into more than 100 asset guideline classes (generally corresponding to those set

out in Rev. Proc. 62-21) based on the business and industry of the taxpayer. Each class of

assets (other than land improvements and buildings) was given a class life as well as a

range of years (called "asset depreciation range") that was approximately 20 percent above

and below the class life. A taxpayer could select a depreciation period from this range and

it would not be challenged by the Service. Thus, the ADR system disassociated an asset’s

depreciation period from its useful life but treated it as the useful life for all income tax

purposes, even though the depreciation period could be significantly shorter than the actual

useful life. However, buildings were generally excluded from the ADR system (except for a

3-year transitional period). The ADR system served as a comprehensive scheme for

dealing with property, including repair and maintenance expenditures (via an optional repair

allowance) and salvage value. The asset guideline set forth in Rev. Proc. 72-10, was

superseded by Rev. Proc. 77-10, 1977-1 C.B. 548, and served as an update to the asset

guideline classes and class lives.

G. Accelerated Cost Recovery System

In 1981, Congress enacted the Accelerated Cost Recovery System (ACRS) to simplify the

depreciation rules and to stimulate the economy by allowing greater deductions over

shorter periods. ACRS eliminated salvage value, minimized exceptions and elections, and

moved away from the useful life concept. ACRS allowed depreciation deductions (this term

is used for convenience; since ACRS is not based on estimated useful lives, cost recovery

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under it may not technically qualify as depreciation) for recovery property over a

predetermined recovery period by applying a statutory percentage to its basis (cost). These

statutory percentages were set forth in a series of tables. In contrast to the elective ADR

system, ACRS was mandatory and provided only five (later six) recovery periods. ACRS

allowed for a faster cost recovery of assets than had been allowed under previous rules

(e.g., the 40-year life for real property was reduced to a 15, 18, or 19-year recovery period,

depending on the placed-in-service date of the property). ACRS was generally applicable

for property placed in service from 1981 through 1986.

ACRS prohibited component depreciation as a method of computing depreciation for

buildings. ACRS required the depreciation deduction for any component of a building to be

computed in the same manner as the deduction allowable for the building, beginning on the

later of the date the component is placed in service or the building is placed in service. See

former § 168(f)(1); Proposed Treas. Reg. §§ 1.168-2(e) and 1.168-6. The driving force

behind this action was to eliminate controversies surrounding the determination of

qualifying § 1245 property (as explained below).

H. Modified Accelerated Cost Recovery System

In 1986, Congress enacted the Modified Accelerated Cost Recovery System (MACRS).

Cost recovery was now based on the applicable depreciation method, the applicable

recovery period, and the applicable convention, as outlined in § 168. MACRS provided two

depreciation systems: the general depreciation system and the alternative depreciation

system (applicable for property used outside the United States, tax-exempt use property,

property for which an alternative depreciation system election has been made, and a

couple of other finite categories not germane to this discussion). MACRS also required

appropriate basis adjustments to compute subsequent year deductions and modified other

ACRS provisions including property classifications. The recovery period for buildings and

structural components increased dramatically. For example, the 15, 18, or 19-year recovery

periods for real property became 39 years for nonresidential real property (31.5 years for

nonresidential real property placed in service before May 13, 1993) and 27.5 years for

residential rental property, under the general depreciation system. Both types of buildings

have a 40-year recovery period under the alternative depreciation system. In Rev. Proc. 87-

57, 1987-2 C.B. 687, the Service furnished optional tables to provide applicable deduction

percentages under MACRS.

The classification of property under MACRS is important because it affects the applicable

depreciation method, recovery period, and convention. Each item of property depreciated

under MACRS is assigned to a property class, which establishes the item’s recovery

period. The applicable recovery periods for MACRS are determined by statute or by

reference to class lives. Class lives for MACRS are set forth in Rev. Proc. 87-56, 1987-2 C.

B. 674. This Rev. Proc. establishes two broad categories of depreciable assets: 1) asset

classes 00.11 through 00.4 that consist of specific assets used in all business activities;

and 2) asset classes 01.1 through 80.0 that consist of assets used in specific business

activities. The same item of depreciable property can be described in both an asset

category (asset classes 00.11 through 00.4) and an activity category (asset classes 01.1

through 80.0), in which case the item is classified in the asset category (unless it is

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specifically included in the activity category). See Norwest Corp. & Subs. v. Commissioner,

111 T.C. 105 (1998) (item described in both an asset and an activity category should be

placed in the asset category). Chapter 4 - Principal Elements of A Quality Cost Segregation

Study and Report provides an overview of asset classifications and recovery period

determinations.

MACRS continued the prohibition against the use of the component method of

depreciation. Although MACRS repealed ACRS § 168(f)(1), which related specifically to

components of § 1250 class property, it enacted § 168(i)(6), which provides that

improvements made to real property are depreciated using the same recovery period

applicable to the underlying property as if the underlying property were placed in service at

the same time the improvements were made. Regarding improvements, the statute refers

to § 1245 property and § 1250 property. § 168(i)(12) provides that the terms “§ 1245

property” and “§ 1250 property” have the meanings given such terms by § 1245(a)(3) and §

1250(c), respectively.

I. Section 1245 and 1250 Property

In 1962, Congress enacted the provisions of §§ 1245 and 1250. These Code sections

result in the conversion of capital gain to ordinary income on the disposition of a property,

to the extent its basis has been reduced by an accelerated depreciation method. The

definitions of property for purposes of §§ 1245 and 1250 are essential for determining

eligibility for a number of other Code provisions (including §§ 167, 168, 179, and former §

48). One of the primary issues in cost segregation studies is the proper classification of

assets as either § 1245 or § 1250 property. The main difference between §§ 1245 and

1250 is whether the provisions apply to the entire amount or an applicable percentage of

the gain.

Section 1245(a)(3) provides that "§ 1245 property" is any property which is or has been

subject to depreciation under § 167 and which is either personal property or other tangible

property (not including a building or its structural components) that was used as an integral

part of certain activities. Such activities include manufacturing, production, or extraction;

furnishing transportation, communication, electrical energy, gas, water, or sewage disposal

services. Certain other "special use" property also qualifies as § 1245 property, but is not

relevant to this discussion. It is important to note that a building or its structural components

is specifically excluded from the definition of § 1245 property.

Treas. Reg. § 1.1245-3 defines "personal property," "other tangible property," "building,"

and "structural component" by reference to Treas. Reg. § 1.48-1. This regulation relates to

former § 48 which was enacted in 1962 along with §§ 1245 and 1250. § 48 allowed an

Investment Tax Credit (ITC) based on the "applicable percentage" of the investment in

tangible depreciable property placed in service during the taxable year. The ITC (§ 48) was

later repealed in 1986.

Section 1250(c) defines "§ 1250 property" as any real property, other than § 1245 property,

which is or has been subject to an allowance for depreciation. In other words, § 1250

property encompasses all depreciable property that is not § 1245 property.

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J. Investment Tax Credit - § 48

Eligible ITC property is defined in former § 48(a)(1) with reference to § 38 (in fact, eligible

property is often referred to as "§ 38 property"). Eligible property included tangible personal

property (other than heating or air conditioning units) and other tangible property (primarily

machinery and equipment) that was closely integrated into the taxpayer's trade or business.

Land, buildings, structural components contained in or attached to buildings, and other

inherently permanent structures generally were not eligible for ITC. Local law was not

controlling with regard to classifying property as tangible personal property for purposes of

ITC.

Treas. Reg. § 1.48-1(c) defines “tangible personal property” as any tangible property

except land and improvements thereto, such as buildings or other inherently permanent

structures (including items which are structural components of such buildings or structures).

Thus, buildings, swimming pools, paved parking areas, wharves and docks, bridges, and

fences are not tangible personal property. Tangible personal property includes all property

(other than structural components) which is contained in or attached to a building. Thus,

such property as production machinery, printing presses, transportation and office

equipment, refrigerators, grocery counters, testing equipment, display racks and shelves,

and neon and other signs, which is contained in or attached to a building constitutes

tangible personal property for purposes of the credit allowed by § 38. Further, all property

that is in the nature of machinery (other than structural components of the building or other

inherently permanent structure) shall be considered tangible personal property even though

located outside a building. For example, a gasoline pump, hydraulic car lift or automatic

vending machine, although annexed to the ground, shall be considered tangible personal

property.

The Senate Report accompanying the enactment of the Revenue Act of 1978 provided

additional insight into Congressional intent by providing further examples of qualifying and

non-qualifying property:

[T]he committee wishes to clarify present law by stating that tangible personal property

already eligible for the investment tax credit includes special lighting (including lighting to

illuminate the exterior of a building or store, but not lighting to illuminate parking areas),

false balconies and other exterior ornamentation that have no more than an incidental

relationship to the operation or maintenance of a building, and identity symbols that

identify or relate to a particular retail establishment or restaurant such as special

materials attached to the exterior or interior of a building or store and signs (other than

billboards). Similarly, floor coverings which are not an integral part of the floor itself such

as floor tile generally installed in a manner to be readily removed (that is it is not

cemented, mudded, or otherwise permanently affixed to the building floor but, instead,

has adhesives applied which are designed to ease its removal), carpeting, wall panel

inserts such as those designed to contain condiments or to serve as a framing for picture

of the products of a retail establishment, beverage bars, ornamental fixtures (such as

coats-of-arms), artifacts (if depreciable), booths for seating, movable and removable

partitions, and large and small pictures of scenery, persons, and the like which are

attached to walls or suspended from the ceiling, are considered tangible personal

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property and not structural components. Consequently, under existing law, this property

is already eligible for the ITC. [S. Rep. No. 1263, 95th Cong., 2d Sess. 117 (1978),

reprinted in 1978-2 C.B. Vol. 1 315, 415.]

Treas. Reg. § 1.48-1(e)(1) defines a "building" as any structure or edifice enclosing a space

within its walls, and usually covered by a roof, the purpose of which is, for example, to

provide shelter or housing, or to provide working, office, parking, display, or sales space.

The term includes, for example, structures such as apartment houses, factory and office

buildings, warehouses, barns, garages, railway or bus stations, and stores. It also includes

any such structure constructed by, or for, a lessee even if such structure must be removed,

or ownership of such structure reverts to the lessor, at the termination of the lease.

Specifically excluded from the definition of the term "building" are: (i) a structure which is

essentially an item of machinery or equipment, or (ii) a structure which houses property

used as an integral part of an activity specified in [former] § 48(a)(1)(B)(i) if the use of the

structure is so closely related to the use of such property that the structure clearly can be

expected to be replaced when the property it initially houses is replaced. Factors which

indicate that a structure is closely related to the use of the property it houses includes the

fact that the structure is specifically designated to provide for the stress and other demands

of such property, and the fact that the structure could not be economically used for other

purposes. Thus, the term “building” does not include such structures as oil and gas storage

tanks, grain storage bins, silos, fractionating towers, blast furnaces, basic oxygen furnaces,

coke ovens, brick kilns and coal tipples.

Treas. Reg. § 1.48-1(e)(2) provides that "structural components" includes such parts of a

building as walls, partitions, floors, and ceilings, as well as any permanent coverings

therefor such as paneling or tiling; windows and doors; all components (whether in, on, or

adjacent to the building) of a central air conditioning or heating system, including motors,

compressors, pipes and ducts; plumbing and plumbing fixtures, such as sinks and

bathtubs; electric wiring and lighting fixtures; chimneys; stairs, escalators, and elevators,

including all components thereof; sprinkler systems; fire escapes; and other components

relating to the operation or maintenance of a building.

However, the term "structural components" does not include machinery as the sole

justification for the installation of which is the fact that such machinery is required to meet

temperature or humidity requirements, which are essential for the operation of other

machinery or the processing of materials or foodstuffs. Machinery may meet the "sole

justification" test provided by the preceding sentence even though it incidentally provides

for the comfort of employees, or serves, to an insubstantial degree, areas where such

temperature or humidity requirements are not essential. For example, an air conditioning

and humidification system installed in a textile plant to maintain the temperature or humidity

within a narrow optimum range, which is critical in processing particular types of yarn, or

cloth is not included within the term "structural components."

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K. Tests for Distinguishing § 1245 and § 1250 Property

There is no general bright-line test for segregating property into § 1245 property and

§ 1250 property classifications. Each situation is factually intensive and is dependent on the

particular facts and circumstances involved.

From a regulatory standpoint, the primary test for determining whether an asset is § 1245

property eligible for ITC is to ascertain that it is not a building or other inherently permanent

structure, including items which are structural components of such buildings or structures.

In other words, if an asset is not a building or a structural component of a building, then it

can be deemed to be § 1245 property. The determination of structural component hinges

on what constitutes an inherently permanent structure, how permanently the asset is

attached to such a structure and whether it relates to the operation or maintenance of the

structure. See Treas. Reg. §§ 1.48-1(c)-(e).

Early administrative rulings by the Service on ITC focused on the use of a "functional” or

“equivalency” test. This test is based on the determination that if the primary use of

property is to provide for the functions normally served by inherently permanent structures

or structural components thereof, then the property should be so classified. Several courts,

however, rejected this approach.

In Rev. Rul. 75-178, 1975-1 C.B. 9, the Service reconsidered its position based on the

contrary case law. It states, “The use of a functional or equivalency test (1) to classify

property as inherently permanent where it is not itself physically attached to the land, or (2)

to classify property as a structural component where it is not an integral part of (and

therefore a permanent part of) a building, is no longer the criteria to be used to classify

property. Rather, the problem of classification of property as ‘personal’ or ‘inherently

permanent’ should be made on the basis of the manner of attachment to the land or the

structure and how permanently the property is designed to remain in place.” Thus, the test

to be used to determine whether an asset is tangible personal property is the inherently

permanent test.

L. Inherently Permanent Test

The seminal case involving the determination of whether an asset is inherently permanent

is Whiteco Industries, Inc. v. Commissioner, 65 T.C. 664 (1975). The Tax Court noted that

“tangible personal property” is not intended to be defined narrowly, nor to follow the rules of

State law where fixation to the land is a basis for distinguishing personal property from

other property. It further stated that assets accessory to the operation of a business, such

as machinery, printing presses, office equipment, individual air-conditioning units, display

racks and shelves, etc., generally constitute tangible personal property for purposes of

§ 48, even though such assets may be termed fixtures under local law. Based on an

analysis of prior case law, the Tax Court put forth six questions designed to ascertain

whether a particular asset qualifies as tangible personal property. These questions, also

referred to as the "Whiteco factors," are:

1. Is the property capable of being moved, and has it in fact been moved?

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2. Is the property designed or constructed to remain permanently in place?

3. Are there circumstances, which tend to show the expected or intended lengths of

affixation, i.e., are there circumstances, which show that the property may or will

have to be moved?

4. How substantial of a job is the removal of a property and how time-consuming is it?

Is it “readily removable”?

5. How much damage will the property sustain upon its removal?

6. What is the manner of affixation of the property to the land?

It should be noted that movability is not determinative in measuring permanence. The court

in Whiteco held that affixation to land does not per se exclude the property from the

category of tangible personal property. Additionally, in L.L. Bean, Inc. v. Commissioner,

T.C. Memo. 1997-175, aff'd, 145 F.3d 53 (1st Cir. 1998), the court held that the mere fact

that a structure is theoretically capable of being moved does not conclusively establish that

it is not inherently permanent.

Examiners should also consider the following additional factors when addressing

permanency (some of which may overlap with the Whiteco factors):

• History of the item or similar items being moved;

• Manner in which an item is attached to a building or to the land;

• Weight and size of the item;

• Function and design of the item;

• Intent of the taxpayer in installing the item;

• Time, cost, manpower, and equipment required to move the components;

• Time, cost, manpower, and equipment required to reconfigure the existing space if

the item is removed;

• Effect of the item’s removal on the building; and

• Extent the item can be reused after removal.

See Amerisouth XXXII, Ltd. V. Commissioner, T.C. Memo. 2012-67; Trentadue v.

Commissioner, 128 T.C. 91 (2007); PDV America, Inc. and Subs. v. Commissioner, T.C.

Memo. 2004-118; Hospital Corp. of America and Subs. v. Commissioner, 109 T.C. 21

(1997).

Please note that land improvements may or may not be inherently permanent. Asset Class

00.3 of Rev. Proc. 87-56 describes land improvements as depreciable improvements made

directly to or added to land, whether such improvements are § 1245 property or § 1250

property. Examples of land improvements include sidewalks, roads, canals, waterways,

drainage facilities, sewers, wharves and docks, bridges, fences, landscaping, shrubbery,

and radio and television transmitting towers. Buildings and structural components are

specifically excluded from the category of land improvements. Land improvements may

also be included in some activity asset classes such as asset class 57.1 of Rev. Proc. 87-

56.

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M. Hospital Corporation of America Case

In Hospital Corporation of America v. Commissioner, 109 T.C. 21 (1997) (“HCA”), the

taxpayer classified as tangible personal property certain items relating to hospital facilities

and claimed depreciation deductions using a 5–year recovery period. The Service took the

position that a number of those items were structural components of the related buildings

and that they must be depreciated over the same recovery period as the buildings to which

they related. The Service also argued that using a different recovery period for the disputed

property items than for the buildings to which they relate in effect results in component

depreciation, which is a method that is no longer permitted under ACRS and MACRS (§

168(f)(1) and § 168(i)(6), respectively). Thus, according to the Service, the tests developed

under the ITC to differentiate between § 1245 property and § 1250 property were

inapplicable to ACRS and MACRS.

The Tax Court held that at the time ACRS was enacted, Congress did not intend to

redefine § 1250(c) to include property which was considered under long-standing

precedent to constitute § 1245 property. Thus, the precedent that was developed to

ascertain whether property constituted eligible § 38 property for purposes of ITC was

equally applicable to ascertain whether property constituted § 1245 property for purposes

of ACRS/MACRS. Conversely, to the extent that property did not qualify as eligible § 38

property for purposes of ITC, the property cannot constitute § 1245 property for purposes of

ACRS/MACRS. The court further held that the prohibition contained in § 168 against the

use of component depreciation applied only to § 1250 property.

In an Action on Decision (AOD-1999-008), the Service acquiesced to the decision in HCA

to the extent that the term “tangible personal property” as defined under the ITC remained

applicable under both ACRS and MACRS. The Service, however, did not agree with the

court’s determinations as to whether the various assets at issue constituted tangible

personal property.

N. Electrical Distribution Systems

Pursuant to HCA, cost segregation methodologies previously used to allocate the cost of a

building between ITC property and structural components likewise can be used for

segregating § 1245 property from § 1250 property. However, this does not necessarily

mean that an asset is exclusively either § 1245 property or § 1250 property; certain assets

can contain characteristics of both code sections. Regarding primary and secondary

electrical distribution systems, the court in HCA concluded that the portion of the cost of the

primary and secondary electrical distribution systems corresponding to the percentage of

the electrical load carried to the hospitals' equipment constituted as § 1245 property,

whereas the portion corresponding to building operations constituted as § 1250 property.

As a result of the ruling in HCA, the Tax Court followed its precedent in Morrison, Inc. v.

Commissioner, T.C. Memo. 1986-129, and Scott Paper Co. v. Commissioner, 74 T.C. 137

(1980).

In Scott Paper, the court focused on the ultimate uses of power at the taxpayer's facility and

distinguished the power used in the overall operation or maintenance such as lighting,

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heating, ventilation and air-conditioning of the building from the power used to operate the

taxpayer's machinery. It held that items which occur in an unusual circumstance and do not

relate to the operation or maintenance of a building should not be structural components

despite being listed in Treas. Reg. § 1.48–1(e)(2). To the extent that the primary electric

carried electrical loads to be used for the taxpayer’s production processes or other such

qualifying uses, the investment credit was allowed for the primary electric improvements; to

the extent that the primary electric related to the overall operation or maintenance of

buildings, they were structural components of such buildings such that they did not qualify

as tangible personal property for purposes of the ITC. This became known as the functional

allocation approach. Hence, the court made an allocation of the facility’s primary electric

between § 1245 property and § 1250 property.

In Morrison, the court followed the functional allocation approach from Scott Paper and held

that the electrical distribution systems were not structural components to the extent of the

load percentages that were carried to equipment (§ 1245 property). On appeal, 891 F.2d

857 (11

Cir. 1990), the Circuit Court affirmed the decision in the Tax Court. It also made

three broad announcements with regard to the electrical distribution system issue. First,

taxpayers can claim ITC on a percentage basis. Second, it adopted the Tax Court’s method

of focusing on the ultimate use of electricity distributed with regard to the electrical system.

Third, the Tax Court’s method is consistent with the ITC’s purpose to provide an incentive

for businesses to make capital contributions. Subsequent to the Eleventh Circuit’s opinion

in Morrison, the Service issued AOD-1991-019 in which it stated that the Service would not

challenge the functional allocation approach set forth in Scott Paper to determine the

eligibility of electrical systems of a building to qualify as § 38 property. For a more detailed

explanation of the functional allocation approach, please see Chapter 8.A - Electrical

Distribution Systems.

Case law has extended the reasoning of Scott Paper to such items as electrical wiring,

outlet receptacles, electrical connectors, telephone connection equipment, fire protection

systems, water piping and lines, drain lines, gas lines, and plumbing and gas connectors.

See Amerisouth, supra, HCA, supra; Morrison, supra; Texas Instruments, Inc. v.

Commissioner, T.C. Memo 1992-306; Duaine v. Commissioner, T.C. Memo.1985–39.

Please note, however, that the functional allocation approach is only applied to a building’s

primary and secondary electrical distribution systems.

O. Incentives for Cost Segregation and Cost Recovery

The tax code provides numerous incentives for taxpayers to perform cost segregation

studies and allocate costs to § 1245 property. Aside from a shortened cost recovery period

(since § 1245 property has shorter lives than § 1250 property), certain incentives generally

apply to tangible personal property (§ 1245 property) and not real property (§ 1250

property). Some of these incentives include:

• § 168(k), Special Allowance for Certain Property (i.e., Bonus Depreciation)

• § 179, Election to Expense Certain Depreciable Business Assets Other incentives

included in the tax code, however, may reduce the need for a taxpayer to perform a

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cost segregation study because they give preferential treatment for certain qualifying

§ 1250 property. Some of these incentives include:

• § 168(e)(6), Qualified Improvement Property

• Former § 168(e)(6), Qualified Leasehold Improvement Property

• Former § 168(e)(7), Qualified Restaurant Property

• Former § 168(e)(8), Qualified Retail Improvement Property

• Former § 1400L, Tax Benefits for New York Liberty Zone

• Former § 1400N, Tax Benefits for Gulf Opportunity Zone

The requirements and restrictions for using the above incentives can be complex. In

addition, the eligibility and the amount of the deduction allowed by the above incentives has

changed over time such that one needs to pay special attention to the placed-in-service

date of the property at issue. You may wish to contact the Practice Network that has

jurisdiction over the incentive to ensure that the applicable provisions are properly followed.

P. Audit Guidance

The Service issued a series of Field Directives to effectively use resources in the

classification and examination of a taxpayer who is recovering costs through depreciation

of tangible property used in the operation of a business. The directives were issued for a

variety of industries including casinos, restaurants, retail industries, biotech and

pharmaceutical industries, and auto dealerships. The directives contained matrices and

related definitions as tools to reduce unnecessary disputes and foster consistent audit

treatment. The directives specified that if the taxpayer’s tax return position was consistent

with the recommendations in the matrix, then examiners should not make adjustments to

categorization and lives. If the taxpayer reported assets differently, however, then

adjustments should be considered. See Chapter 7 of this Guide for matrices applicable to

various industries.

Q. Summary

This chapter has provided a legal framework for cost segregation by providing a brief

history of depreciation, discussing various asset classification and cost recovery models,

defining relevant terms, examining the former investment tax credit (ITC), explaining tests

for distinguishing § 1245 property from § 1250 property, showing how cost segregation

principles transferred from the ITC to current cost recovery systems, clarifying how cost

segregation applies to building systems, enumerating incentives for cost segregation, and

conversing about audit tools.

It cannot be overemphasized that the classification of assets is a factually intensive

determination. There are no bright-line tests for segregating property into § 1245 property

and § 1250 property classifications. Based on the final tangible regulations released in

September 2013, it is expected that the use of cost segregation studies by taxpayers will

increase. Thus, examiners need to examine and evaluate a cost segregation study in light

of the applicable statutes, regulations, and judicial precedent.

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Chapter 3 – Cost Segration Approaches

A. Introduction

Cost segregation studies are conducted for a variety of reasons (e.g., income tax, financial

accounting, insurance purposes, and property tax). For income tax purposes, cost

segregation studies involve the allocation (or reallocation) of the total cost (or value) of

property into the appropriate property classes and recovery periods in order to properly

compute depreciation deductions. The results of cost segregation studies are typically

summarized in an accompanying cost segregation report. At this time, there is no standard

format for either cost segregation or cost segregation reports.

The methodology or approach utilized in allocating total project costs to various assets is

critical to achieving an accurate cost segregation study. The terms “methodology” and

“approach” are often used interchangeably in discussions of cost segregation; however, to

simplify, the term “approach” is used in this ATG. Also, in this ATG, the term “cost

segregation” refers to the process of performing cost segregation and the term “cost

segregation report” refers to the written report that conveys the results of the cost

segregation. This chapter summarizes some of the more common approaches to cost

segregation and their potential drawbacks. This discussion should assist the examiner in

evaluating the accuracy of the cost segregation and in performing a risk analysis with

respect to the depreciation deductions based on the cost segregation.

Cost segregation is generally performed for either newly constructed property or acquired

property. Each of these situations requires a very different overall approach.

Newly constructed property, which includes remodels of existing properties and additions to

existing properties, usually involves construction that was completed for the taxpayer that

has occurred relatively recently. The cost segregation is normally performed either at the

completion of the construction project or soon after. At this point, direct cost information

(from contractors, vendors, suppliers, etc.) and indirect cost information (from architects,

engineers, construction testing firms, local government building departments, etc.) is

generally readily available from the taxpayer. Also, construction documents that were used

for the construction project (construction drawings, specifications, contract documents, etc.)

are generally readily available as well.

Acquired property involves existing properties that are purchased by the taxpayer. The

acquired property could have been constructed fairly recently or far in the past. The

available cost and construction information may range from as much as that available for a

newly constructed property down to nothing more than the basis of the property.

When construction cost information for a property is not available, it must be reconstructed

using the construction cost data, methods, and techniques normally employed for property

appraisal. The reconstructed cost is then adjusted for the current physical condition of the

property at the time of acquisition and finally adjusted to match the actual amount paid by

the taxpayer for the property.

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B. What are the Most Common Approaches Utilized for Cost Segregation

Studies?

Various approaches may be utilized in completing cost segregation, including:

1. Detailed Engineering Approach from Actual Cost Records

2. Detailed Engineering Cost Estimate Approach

3. Survey or Letter Approach

4. Residual Estimation Approach

5. Sampling or Modeling Approach

6. "Rule of Thumb" Approach

Examiners should not necessarily expect to see the approach that was used for a cost

segregation mentioned in a cost segregation report. Some cost segregation reports may

describe the approach that was used for the cost segregation in great detail and some cost

segregation reports may not mention the approach that was used at all. However, based on

the information in this chapter, an examiner should be able to recognize the attributes of

the cost segregation and identify the approach that was used (and also identify the

potential drawbacks of the approach). It should be noted that other approaches not

mentioned here may be used, although most are merely derivatives of the approaches

discussed in this chapter.

C. What are the Attributes of the Various Cost Segregation Approaches?

The following discussion takes a closer look at the steps involved and the attributes of each

of the approaches listed above. Keep in mind that these are the steps normally taken when

completing cost segregation. The examiner's responsibility is to review the steps taken in

the cost segregation and to evaluate the accuracy of the cost segregation and, additionally,

to evaluate the quality of the accompanying cost segregation report. Chapter 5 - Review

and Examination of Cost Segregation Study provides guidance in how to review cost

segregation and cost segregation reports.

1. Detailed Engineering Approach from Actual Cost Records

The detailed engineering approach from actual cost records, also called the “detailed cost

approach” or “direct cost method”, uses cost information from contemporaneous

construction and accounting records. In general, it is the most methodical and accurate

approach, relying on solid documentation of the construction costs and minimal cost

estimating. Construction documentation, such as construction drawings, specifications,

contracts, job reports, change orders, payment requests, and vendor and supplier invoices,

are used to determine unit costs. The use of actual cost records in this approach

contributes to the overall accuracy of cost allocations, although issues may still arise as to

the proper classification of specific assets. Refer to Chapter 6.F - Construction Process, for

a discussion of a typical construction project and an explanation of the construction cost

information and documentation mentioned above.

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The detailed engineering approach from actual cost records is generally applicable only to

new construction, where detailed direct cost information (from contractors, vendors,

suppliers, etc.) and indirect cost information (from consultants, testing firms, local

government building departments, etc.) is readily available.

The detailed engineering approach from actual cost records typically includes the following

activities:

• Identify the specific project and assets that will be analyzed in the cost segregation.

• Obtain information on all direct and indirect project costs. Substantiate the total

project cost and reconcile the cost segregation to the total project cost.

• Conduct a site visit to inspect the facility. Determine the nature of the facility, its

intended use, and identify the specific assets that are contained within the facility

and on the facility site.

• Photograph specific assets for reference. Request any available photographs that

document the condition of the property prior to the start of construction as well as

progress photographs that document the progress of the construction during the

construction project.

• Review record drawings, specifications, contracts, bid documents, contractor pay

requests, change order detail, and any other construction cost information or

documentation that is available.

• Assign the specific assets identified in the document review and site visit to property

classes and recovery periods (e.g., land, land improvements, building, equipment,

furniture and fixtures, and other items of tangible personal property).

• Prepare quantity take-offs for all assets and use contractor cost information to

compute unit costs.

• Apply unit costs to each asset to determine its total cost basis. Reconcile the total

costs basis obtained from quantity take-offs to the total actual contractor costs.

• Allocate indirect costs to the appropriate assets. This allocation is normally done on

a pro rata basis for indirect costs applicable to the entire project and on a specific

basis for indirect costs applicable only to specific assets.

• Group assets with similar class lives, recovery periods, and placed-in-service dates

to simplify depreciation computations and the entry of the assets into the taxpayer’s

fixed assets system.

Even though the detailed engineering approach from actual cost records generally provides

the most accurate cost allocations for the assets, the examiner should recognize that the

proper cost basis and recovery periods of the Internal Revenue Code (IRC) § 1245

property analyzed in the cost segregation could still be an issue even when this approach is

used.

2. Detailed Engineering Cost Estimate Approach

The detailed engineering cost estimate approach (or detailed estimate approach) is similar

to the detailed cost approach. The difference is that the detailed estimate approach

estimates costs, rather than using actual costs. This approach is used when cost records

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are not available such as for an acquisition of used property. In the context of an

acquisition, additional steps must be taken to determine the values of the acquired assets,

such as addressing physical depreciation and functional obsolescence in the cost approach

and addressing other approaches to value.

The detailed estimate approach is methodical, relying on solid documentation and utilizing

construction-based documents such as blueprints, specifications, contracts, job reports,

change orders, payment requests, invoices, appraisals, etc. When estimates are required,

they are based on costing data, either from contractors or from reliable published sources

(e.g., R. S. Means or Marshall Valuation Service). The sources of estimating data are

clearly referenced, including identification of the specific volume, page, and item number.

Further, the same estimating techniques and unit cost data sources are used for all of the

items that comprise the actual cost.

In essence, the steps for this approach are the same as the detailed cost approach, except

for Step 7 (in which costs come from contractor estimates or estimating guides). However,

if detailed cost estimates are prepared methodically, and the estimates are reconciled to

actual costs, then reasonably-accurate cost allocations are possible.

A field inspection is recommended for all quality studies, whether the studies are for new or

used properties. When construction drawings and specifications are limited or are not

available, which is often the case for used or acquired property, field inspection of the

property is a critical step. This field inspection should document the physical details of the

building, type of construction, materials used for construction, the assets contained in the

building, the size and types of building systems (HVAC, plumbing, fire protection, electrical,

data and communications, etc.), and any land improvements (such as parking lots,

sidewalks, site lighting, etc.) that were included in the purchase of the property and the

condition of that property at the time of purchase. It is important that this field inspection be

completed thoroughly and accurately as it forms the starting point for reconstructing the

construction costs of the property.

3. Survey or Letter Approach

The survey or letter approach is an alternative method for estimating costs for newly

constructed property. In this approach, contractors and subcontractors are contacted via a

survey or letter to provide information on the cost of specific assets that they installed on a

particular project. These costs are then used in one of the engineering approaches or in the

residual estimation approach (discussed in the following section). Cost allocation using the

survey approach involves the following steps:

• Complete Steps A - F of the detailed engineering approach from the actual cost

records to identify the specific property items that require cost estimates. Estimates

should be reconciled to an actual cost if possible [either to an overall project cost or

to an individual system cost (e.g., plumbing, electrical)].

• Divide property items by contractor and/or subcontractor.

• Ask contractors and/or subcontractors to provide the quantities and prices of specific

property items.

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• Use unit cost estimates obtained from the surveys to determine and allocate

property costs.

In situations where the contractor provides actual cost data, the allocations may be

reasonably reliable. However, when contractor data is obtained from other sites or projects,

the data may not be comparable or reliable. The amount of detail provided by different

contractors may also vary. The wide disparity in cost estimation methods dictates the use

of caution to ensure that the total allocated costs do not exceed the actual total project cost.

4. Residual Estimation Approach

The residual estimation approach is an abbreviated method in which only short-lived asset

costs (e.g., 5- or 7-year property) are determined. Short-lived asset costs are added

together and then subtracted from the total project cost. The remaining or “residual” cost is

then simply assigned to the building and/or other long-lived assets. Although this method is

simpler and less time consuming than the engineering approaches, it can also be less

accurate.

It should be recognized that this method generally does not reconcile project costs. In

general, residual costs are not estimated or checked for reasonableness. A proper and

“reasonable” residual cost should always be determined and then added back to the total of

all short-lived asset costs to check if the total project cost is reconciled.

It should also be understood that different estimation techniques for short-lived assets can

produce a skewed result in favor of § 1245 property (e.g., § 1245 property based on single-

unit costs for high quality construction, while the building is based on gross square

footage).

5. Sampling or Modeling Approach

The sampling or modeling approach uses a created model (or template) to analyze multiple

facilities that are nearly identical in construction, appearance, and use (e.g., fast food

chains and retail outlets). The use of sampling minimizes resources and costs compared to

conducting studies on all properties.

Typical steps are:

• Stratify properties by facility type (e.g., free-standing facility, mall location, leased or

owned property, etc.).

• Perform a cost segregation study by sampling properties within each stratum.

• Based on the results in Step B, develop a standard model for each type of facility.

• Apply the costs derived from the model(s) to the population on a percentage basis.

For example, the model may indicate that 10% of the project costs are allocable to

5-year property. This same percentage is then applied to each facility within the

same stratum.

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A frequent issue is the accuracy of the sampling results. In some cases, the sampling

method may not be statistically valid. In addition, a population less than 50 could limit the

accuracy of a sampling technique, unless an appropriate sampling error is considered.

Also, despite the fact that facilities within certain strata may appear to be very similar,

variations in building codes, geographic location, and material and labor costs may make it

difficult to determine an appropriate model. Statistical sampling is discussed in more detail

in Chapter 5 - Review and Examination of a Cost Segregation Study.

6. "Rule of Thumb” Approach

Some cost segregation studies are merely based on a "rule of thumb” approach. In general,

this approach uses little or no documentation and is based on a preparer's "experience" in

a particular industry. For example, a preparer will estimate IRC § 1245 property as a fixed

percentage of project cost by relying on previously determined “industry averages” (e.g.,

40% for a manufacturing facility). An examiner should view this approach with caution,

since it lacks sufficient documentation to support its allocation of project costs.

D. What Approach is Required by the IRS?

Neither the Internal Revenue Service (Service) nor any group or association of practitioners

has established any requirements or standards for the preparation of cost segregation

studies. The courts have addressed component depreciation but have not specifically

addressed the methodologies of cost segregation studies.

The Service has addressed this issue but only briefly, i.e., Revenue Ruling 73-410, 1973-2

C.B. 53, Private Letter Ruling (PLR) 7941002 (June 25, 1979), Chief Counsel Advice

Memorandum 199921045 (April 1, 1999). These documents all emphasize that the

determination of § 1245 property is factually intensive and must be supported by

corroborating evidence. In addition, an underlying assumption is that the study is performed

by "qualified individuals” and “professional firms” that are competent in design,

construction, auditing, and estimating procedures relating to building construction (See PLR

7941002).

Despite the lack of specific requirements for preparing cost segregation studies, taxpayers

still must substantiate their depreciation deductions and classifications of property.

Substantiation using actual costs is more accurate that using estimates. However, in

situations where estimation is the only option, the methodology and the source of any cost

data should be clearly documented. In addition, estimated costs should be reconciled back

to actual costs or purchase price.

E. Summary and Conclusions

Cost segregation studies are prepared for a variety of reasons (e.g., income tax, financial

accounting, insurance purposes, property tax), and many different methodologies and

procedures are used. While neither the Service nor any group or association of

practitioners prescribes a specific methodology, there are certain approaches (e.g., studies

based on actual costs or on proper estimation techniques) that produce more accurate and

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reliable allocations. Despite the use of one of these more reliable methods, issues may still

arise with respect to the proper classification of IRC § 1245 property.

Approaches that yield accurate cost allocations expedite the Service's review, saving time

and resources for taxpayers, practitioners, and Service examiners alike. A study that is

both accurate and well documented is considered (in this ATG) a “quality” cost segregation

study. The specific characteristics that comprise a quality study are described in Chapter 4

- Principal Elements of a Quality Cost Segregation Study and Report.

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Chapter 4 – Principal Elements of a Quality Cost Segregation Study and

Report

A. Introduction

As discussed in the last chapter, there is no standard format for cost segregation studies.

Thus, examiners will encounter a wide variety of studies and reports, as well as supporting

documentation. For example, some studies will be very brief and other studies may be

quite voluminous and complex. Regardless of the length of a study or the methodology

used, a cost segregation study and report should always:

• Classify assets into property classes (e.g., land, land improvements, building,

equipment, furniture and fixtures);

• Explain the rationale (including legal citations) for classifying assets as either § 1245

or § 1250 property: and

• Substantiate the cost basis of each asset and reconcile total allocated costs to total

actual costs.

B. What is a “Quality” Cost Segregation Study?

A “quality” cost segregation study is a study that is both accurate and well-documented with

regard to the three points above. Quality studies greatly expedite the Service’s review,

thereby minimizing the audit burden on all parties. A quality study contains a number of

characteristics, which are set forth below.

C. Principal Elements of a Quality Cost Segregation Study

The 13 principal elements of a quality study are:

1. Preparation by An Individual with Expertise and Experience

2. Detailed Description of The Methodology

3. Use of Appropriate Documentation

4. Interviews Conducted with Appropriate Parties

5. Use of A Common Nomenclature

6. Use of A Standard Numbering System

7. Explanation of The Legal Analysis

8. Determination of Unit Costs and Engineering “Take-Offs”

9. Organization of Assets into Lists or Groups

10. Reconciliation of Total Allocated Costs to Total Actual Costs

11. Explanation of The Treatment of Indirect Costs

12. Identification and Listing of § 1245 Property

13. Consideration of Related Aspects (e.g. I.R.C. § 263A, Change in Accounting

Method and Sampling Techniques)

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1. Preparation by An Individual with Expertise and Experience

The preparation of cost segregation studies requires knowledge of both the construction

process and the tax law involving property classifications for depreciation purposes.

Unfortunately, there are no prescribed qualifications for cost segregation preparers.

However, a preparer’s credentials and level of expertise may have a bearing on the overall

accuracy and quality of a study.

In general, a study by a construction engineer is more reliable than one conducted by

someone with no engineering or construction background. However, the possession of

specific construction knowledge is not the only criterion. Experience in cost estimating and

allocation, as well as knowledge of the applicable tax law are also important criteria.

A quality study identifies the preparer and always references their credentials,

experience, and expertise in the cost segregation area.

2. Detailed Description of The Methodology

Chapter 3 – Cost Segregation Approaches discusses the most common approaches and

methodologies used in preparing cost segregation studies. However, an actual study may

be based upon a variant or combination of methods and, in fact, may not even identify by

name the method used.

A quality study always describes the methodology that was used and details the

steps that were taken to classify assets and determine costs.

3. Use of Appropriate Documentation

A quality study uses the best available documentation to classify assets and

determine costs. Documentation supporting a quality study will vary, depending on

whether a property is new or used or whether original construction documents are

available. Contemporaneous documentation is the most reliable and trustworthy. The

documentation in a quality study for both new and used properties is detailed below.

• New Construction

• Allocation of Land and Land Development Costs

A quality study explains the treatment of land and land development costs, (e.g.,

survey, subdivision costs, and temporary roads,). Generally, these costs are allocated to

non-depreciable land accounts. Also included in this account are the costs of improvements

or land that are transferred to a local municipality (to obtain approval for subdividing or for a

change in use).

• Site Visit

A quality study includes a site visit to gain a better perspective and understanding of the

design and purpose of the project, as well as the use of specific assets. Before-and-after

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photographs are used to establish land and site preparation costs (i.e., surveying, clearing,

grubbing, general grading and compaction).

• Construction Documents, Blueprints, Construction Drawings, Specifications

and Contractor Payments

o A quality study reviews all pertinent construction documentation. The

taxpayer’s capital expenditure request is reviewed to ascertain the intended

functional use of a building and other assets included in the project. Site,

architectural, and engineering plans, as well as "as-built" or record drawings,

blueprints and bid documents, are all reviewed and referenced in a quality study.

The specific assets deemed to be § 1245 property are clearly highlighted or

otherwise identified on the “as-built” or record drawings. Project specifications

are analyzed to determine conformity to the blueprints. Purchase and change

orders are also reviewed to ascertain cost information, changes in costs, and

details of the work performed.

o A quality study reviews the “General Contractor's Applications for

Payment” (AIA Forms G-701, G-702, G-703, and G-704) to ascertain what was

actually paid for during construction. In addition, subcontractor payment

applications, as well as invoices paid for items outside the scope of the general

contractor’s work, will be reviewed to provide greater insight and detail of the

construction. Actual or estimated costs are cross-referenced to the supporting

documentation.

• Acquired or Used Properties

Cost segregation studies on used real property should be performed by qualified appraisers

and should properly allocate the purchase price between the non-depreciable land, building

and personal property based on their value as of the date of purchase. See AmeriSouth

XXXII, Ltd. v. Commissioner, T.C. Memo. 2012-67.

• Purchase Price Allocations

A quality study documents how the purchase price was allocated between land, land

improvements, building and other assets. Land value is always determined first and is

based on “highest and best use.” In simple terms, highest and best use means the

probable use of land that result in its highest value. The balance of the purchase price is

then allocated to the building and to other assets based on their value as of the date of

purchase.

• Address Physical Deterioration and Functional Obsolescence

The lack of cost records and the age of a property add to the uncertainty in determining its

value or cost. In making this determination, a quality study always accounts for the

physical deterioration and functional obsolescence of assets. It also provides the

documents and the corroborating evidence used to determine values or costs.

• Site Visit

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Similar to quality studies completed for new construction, a quality study for acquired or

used properties includes a site visit, as well as photographic evidence, to assist in

identifying the assets and in determining the allocations of values or costs.

• Review of Purchase or Lease Agreements and Appraisals

As discussed above under new construction, original construction documents, such as

construction drawings, specifications, change orders and contractor pay applications, are

used in a quality study to classify assets and determine costs. When original

construction documents are not available, as is often the case with acquired or used

property, a quality study will support its allocations by using other corroborating

evidence (e.g., purchase/lease agreements, appraisals). A quality study will review the

purchase agreement as a first step. This is important to identify the assets acquired and to

identify any contract allocations of the purchase price. If the property is leased, the lease

agreement will be reviewed and documented. A quality study will also review any

appraisals, if applicable. The availability of historical construction records will also be

addressed in a quality study (i.e., if these are not available, the study will indicate what

efforts were made to obtain these records).

4. Interviews Conducted with Appropriate Parties

Interviews with contractors and subcontractors, as well as with taxpayers and property

managers, are quite valuable in ascertaining the specific use of a property and the

construction process involved. A quality study documents all interviews conducted

with appropriate parties, thus adding credibility to the depth and accuracy of its study.

However, the examiner should recognize that subcontractor work details can be difficult to

obtain since taxpayers generally have had no direct contact with them. In addition, general

contractors may also be reluctant to share certain information because of confidentiality

(e.g., profit margins).

5. Use of A Common Nomenclature

The use of creative or misleading nomenclature to describe property items, rather than

common and clearly understood terms, detracts from the quality of a study. “Creative”

descriptions may be used to disguise the true nature or character of an asset (e.g., a

building sewage or water piping system referred to as "process piping"; an emergency exit

sign termed "decorative placard").

A quality study always uses terminology consistent with the blueprints and other

project documents (e.g., contract specifications, pay requests, etc.). The use of

common and clearly understood terms facilitates the Service’s review and avoids the

confusion caused by misleading terms.

6. Use of A Standard Numbering System

The use of a standard numbering system, such as the Construction Specification Institute

(CSI) Master Format Division, is helpful. A quality study numbers assets consistent

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with the contract bid documents and pay requests. This numbering system facilitates

classifying property for computing depreciation and thus expedites the Service’s exam.

The CSI format categorizes costs by specific building systems or components, such as

concrete, carpentry, metals, woods and plastics, mechanical, electrical and lighting. Other

typical groupings of assets may include land, land improvements, furniture and fixtures,

electrical systems, plumbing systems, equipment, etc. Refer to Special Topics Chapter 6.F

– Construction Process, which provides a more detailed discussion of standard numbering

systems.

7. Explanation of The Legal Analysis

A quality study contains a thorough legal analysis, including relevant citations, to

support its § 1245 property classifications. The treatment of some items may be fairly

clear based on consistent judicial decisions. In other instances court decisions may appear

to be inconsistent, or the Service has not acquiesced in the decision. These apparent

incongruities reflect the intensely factual basis that underlies the proper classification of

property. As might be expected, the proper classification of property is the source of much

audit controversy.

The legal discussion in a quality study recognizes these conflicts and attempts to reconcile

them to the specific facts and circumstances of the property at issue. An accurate analysis

of the statutes and judicial precedent adds to the overall quality of a study and facilitates

the Service’s review.

8. Determination of Unit Costs and Engineering "Take-Offs"

Once property items or assets have been identified and assigned to property classes (e.g.,

building and personal property), their respective costs must be determined. In order to

determine a cost for each unit or class of property in a project, total project costs must

generally be broken down. This breakdown process is commonly known as engineering

“take-offs”.

In a quality study, engineering "take-offs" are carefully documented to show derived

unit costs, and individual property units are clearly identified or highlighted on the

"as-built" blueprints. For new construction, the cost of property items in an engineering

take-off can generally be obtained from actual cost records. However, when actual costs

are not available, costs must be estimated.

Cost estimates can vary widely depending on which estimating guide is used and whether

costs are for "high" or "low" quality construction. In a quality study, cost estimates are

always reconciled to an acquisition price or a total project cost to ensure the accuracy of an

allocation. The proper use of an estimation technique is another frequent source of audit

controversy. A quality study minimizes this controversy by clearly explaining and

documenting the methodology used to assign costs to each asset.

9. Organization of Assets into Lists or Groups

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Typically, a study lists assets by recovery period (e.g., land, land improvements, furniture

and fixtures, electrical systems, plumbing systems, equipment). To facilitate the Service’s

review, a quality study should list assets and generally tie to a taxpayer's fixed asset

ledger.

10. Reconciliation of Total Allocated Costs to Total Actual Costs

It is important that the same estimating technique be used on all of the items that reconcile

to a purchase price, a project cost, or to a particular property cost. If different methods or

cost guides are used on different property items (e.g., one method for tangible personal

property and a different method for the building), cost distortions arise. A quality study

always reconciles total allocated costs to total actual costs to ensure the accuracy of

its allocations.

A quality study also considers and lists separately acquired § 1245 property to

prevent possible duplication. For example, if the total project cost includes furniture,

fixtures and equipment (FFE), then it is appropriate to allocate costs to those items.

However, if FFE is acquired separately and not included in the total project cost, then it is

not appropriate to assign costs to FFE.

11. Explanation of The Treatment of Indirect Costs

A quality study lists all the costs associated with a particular project, including both

direct and indirect costs, and explains the treatment of any indirect costs. Direct

costs are the labor and material costs for specific items or assets. Indirect costs, also

referred to as "allocables," are intangible costs that are incident to the construction of a

facility. Indirect costs must be allocated proportionately to the basis of the specific assets to

which they relate.

Indirect costs may also include expenditures that should not be allocated to the entire

project but rather assigned to the property class to which they relate. Costs to survey and

subdivide land, and general grading are typically allocable only to land. On the other hand,

costs for building permits, general conditions, and contractor overhead and profit are

typically allocated to assets on a pro-rata basis.

Generally, indirect costs do not relate to the placement of business machinery, or furniture

and fixtures since these assets are typically purchased and installed under separate

contracts. However, indirect costs that specifically relate to components of personal

property may be assigned to § 1245 property. For example, costs for special consultants

(e.g., for computer wiring and process engineering) or costs to design the computer system

may be assigned directly to that system. In addition, it may be reasonable to allocate

certain indirect costs, such as liability insurance, bonds and overhead/profit, where it can

be shown that the total amount of the indirect cost is based upon the pro rata cost of each

class of property.

The treatment of indirect costs is another area of frequent controversy. A quality study

explains the purpose of each indirect cost and describes its allocation.

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12. Identification and Listing Of § 1245 Property

A quality study lists § 1245 property (including amounts) and shows any property

originally classified as § 1250 property that is reclassified to § 1245 property.

13. Consideration of Related Issues (i.e., § 263A, Change in Accounting Method, and

Sampling Techniques)

A quality study addresses related issues, such as § 263A, Change in Accounting

Method, and Sampling Techniques.

The uniform capitalization (UNICAP) rules of § 263A(a) require the capitalization of all

direct costs and certain indirect costs allocable to real property and tangible personal

property produced by the taxpayer. Self-constructed assets and property built under

contract are treated as property “produced” by the taxpayer. Furthermore, § 263A(f)

requires the capitalization of certain interest expenses incurred in connection with the

production of property. For tax years beginning after December 31, 2017, a small business

taxpayer is not required to capitalize costs including interest under § 263A. A small

business taxpayer is a taxpayer that (a) has average annual gross receipts of not more

than $25 million for the 3 prior tax years (adjusted annually for inflation), and (b) is not a tax

shelter as defined in § 448(d)(3).

Although the courts have not uniformly agreed, it is the position of the Service that a

change in depreciation method, recovery period or convention for depreciable property

constitutes a change in accounting method. Therefore, the use of a cost segregation study

to reclassify property and/or reallocate costs generally requires the consent of the

Commissioner. Please refer to Special Topics Chapter 6.B – Change in Accounting Method

for more information.

Studies may utilize sampling techniques when taxpayers have a large number of

substantially similar properties, such as in retail or food stores. Studies may use techniques

such as statistical sampling, modeling, or judgmental sampling.

When conducted properly, statistical sampling can be a reliable technique. However,

improper sampling techniques may result in a final answer that does not accurately reflect a

valid estimate. Factors addressed in a quality study’s sampling technique include the

definition of the population being sampled, the size of the population, a description of

stratification techniques, and the consideration of sampling error.

A modeling approach may also be used to segregate property costs. This approach uses

created models to approximate the different types of units involved. If the models are

properly analyzed, then this method may be reasonably accurate when applied to the entire

population. However, as discussed in Chapter 3 – Cost Segregation Approaches, the

delineation of strata may be difficult and is often an area of controversy. Furthermore,

issues may arise as to whether the sampling method is statistically valid.

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Some studies may rely solely on a judgmental sampling technique, which carries a higher

level of risk due to the elements of subjectivity involved. A judgment sample is typically

selected on the basis of perceived similarities and is not statistically valid. However, under

certain, limited circumstances, the use of a judgment sample may be appropriate. In such a

case, the underlying basis for the selection of particular units in a judgment sample must be

rational and supported by adequate data.

A quality study addresses these related audit issues and comments on the treatment

of these items for tax purposes, especially where the amounts are restated for prior

tax years.

D. Principal Elements of a Quality Cost Segregation Report

A cost segregation report reflects a study’s methodology and conclusions. The amount of

detail included in a report varies considerably since there is no standard or prescribed

format. The following elements are found in a quality report:

1. Summary Letter/Executive Summary

A quality report contains a summary to identify: the preparer, the date of the study, the

taxpayer (or client), the subject property, and the property units classified as land, land

improvements, building or personal property.

2. Narrative Report

A quality report discusses the theory, definitions, and the rationale behind the study

in the narrative section. This section generally includes a more detailed description of the

property/facility (i.e., a physical description and an explanation of the use for which it is

intended, as well as a legal description of the property and its location). In addition, the

narrative section provides a thorough discussion of the regulations, rulings and court cases

that support classifying certain assets as § 1245 property. The narrative also discusses the

types and sources of data used (e.g., cost records, contracts, purchase agreements,

published estimates) as well as how they were used. A list of potential data sources is

included in Special Topics Chapter 6.F – Construction Process.

3. Schedule of Assets

A quality report has a schedule of assets that are the focus of the study. Generally,

this schedule ties directly to the taxpayer's depreciation records. When a taxpayer

reallocates costs of assets already "on the books," a quality report clearly identifies the

specific assets impacted (and includes depreciation records from both before and after the

reallocation).

4. Schedule of Direct and Indirect Costs

A quality report lists all direct and indirect costs associated with a project. Indirect

costs allocated to § 1245 property are clearly identified and explained. Separately-acquired

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assets are listed and discussed in the report to avoid duplication errors. Costs subject to

IRC § 263A are also addressed.

5. Schedule of Property Units and Costs

A quality report provides a detailed schedule of property units and costs (with

property descriptions) that are segregated into land, § 1245 property, and § 1250

property. This schedule is the final product of the study and serves as the basis for

computing depreciation.

6. Engineering Procedures

A quality report describes the engineering procedures and methodology for

determining the cost of each property unit. It also identifies the specific taxpayer

records that were reviewed and discusses whether actual cost records or estimating

techniques were utilized to break costs into smaller property units. A record of inspections

and/or interviews is included as well. The use of a common nomenclature or a standard

numbering system is also referenced and/or explained. Note that the engineering

procedures utilized to perform a quality study will differ based on whether the subject of the

study is new construction or used properties as well as on the amount of the

contemporaneous construction documentation available. The engineering procedures used

for quality studies of new properties and used or acquired properties is discussed in step

C.3 of this chapter.

7. Statement of Assumptions and Limiting Conditions

A quality report describes the general understanding and conditions applicable to

the report. This information may also provide an indication of the overall quality of the

study.

8. Certification

A quality report certifies that the person who signed the report actually developed

the analysis, opinions and conclusions of the report. This section may also include the

resume or state the credentials and/or level of experience of the preparer.

9. Exhibits

A quality report generally includes various exhibits, such as the “Client Cost

Sources” and the “Cost Source Reconciliation.” These exhibits show the “book”

(accounting) records on which the preparer relied in deriving total costs and may include a

reconciliation of the study to the fixed asset ledger. Photographs and/or videos may also be

included as exhibits to assist in identifying and understanding the assets in the study.

E. Summary and Conclusions

This chapter described the principal elements of a "quality" cost segregation study and

report. The degree to which a cost segregation study/report conforms to these elements will

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likely dictate the scope and depth of an examination. A quality study and report will

expedite the exam process, as indicated in Chapter 5 – Review and Examination of a

Quality Cost Segregation Study and Report, and ultimately minimize audit burden on

taxpayers, practitioners, and examiners alike.

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Chapter 5 – Review and Examination of a Cost Segregation Study

A. Introduction

The preceding chapters described the legal framework for classifying assets (Chapter 2),

common methodologies used to segregate costs (Chapter 3), and elements of a quality

cost segregation study and report (Chapter 4). This chapter provides suggested audit steps

for reviewing and examining a cost segregation study and report.

The appropriate audit steps depend on the nature and size of the cost segregation project

as well as on the overall quality of the study. Cost segregation is a factually intensive

determination that is based on complex tax law and engineering analysis. While examiners

may be able to evaluate the adequacy of some cost segregation studies, other studies may

require specialists with expertise, industry or construction experience and specialized

training.

The Engineering Program in the Large Business and International (LB&I) business unit of

the IRS is the principal source of technical expertise for examining cost segregation

studies. The Computer Audit Specialist (CAS) Program in LB&I is also available to provide

assistance when a study is based on statistical sampling. Formal advice, using the referral

process, should be solicited through the LB&I website and the Specialist Referral System

(SRS). Informal advice through consultation is also available by contacting your

engineering or computer audit specialist group. The Senior Revenue Agents in the

Deductible and Capital Expenditures Practice Network (DCE PN) are also available to

assist examiners with this issue. Refer to the DCE PN website for up-to-date information

and guidance on this issue or to submit an inquiry.

Cost segregation studies and fixed asset reviews typically utilize documents and cost

information prepared for purposes of the construction process; Special Topics Chapter 6.F

– Construction Process, provides a brief overview of the construction process. Cost

segregation studies can be examined using a step-by-step approach. The suggested audit

steps below may not apply to all cost segregation studies, however, each step should be

carefully considered and determined to be applicable or not before moving on to the next

one.

B. Steps for Examining a Cost Segregation Study and Report

1. Initial Risk Analysis

1. Risk analysis is the process that compares the potential benefits to be derived from

examining a specific area on a tax return with the resources needed to complete the

examination. Review A Copy of The Cost Segregation Study Report for Initial Risk

Analysis Purposes

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Every Cost Segregation Study should have a report that summarizes the results of the cost

segregation study. The report should provide:

• Background regarding the subject property

• An explanation of the methodology used by the preparer

• Details regarding the assets classified in the study

• The applicable class lives and recovery periods of the assets

• The rationale and authority for the property classifications made in the Study.

Refer to Chapter 4 for a discussion of the principle elements of a quality cost segregation

study and report.

In reviewing a Cost Segregation Study Report for risk analysis purposes, one must read the

report to obtain a general understanding of the study methodology and the property

classifications made therein. The following steps are suggested when reviewing a cost

segregation report for risk analysis purposes:

• Request a copy of the Cost Segregation Study Report. Refer to the IDR Exhibits

in Special Topics Chapter 6.G – Information Document Requests for suggested

language.

• Read the Entire Report with Emphasis on the Property Classifications.

• Review the Property Units and the Types of Assets.

o Assets are generally classified by cost segregation studies into various units or

groups of assets and are often listed in both a "Summary" and a "Detail"

format.

 A “Unit (or Asset) Group” is a group of individual assets that together

form a larger assembly that is considered to be and treated as a single

asset.

 The “Property Unit Summary” is a list summarizing the Unit Groups by

asset class or recovery period (i.e., land, 3, 5, 7, 10, 15, 20, 27.5 and/or

39-year property.)

 The “Property Unit Detail” is a listing of the individual assets that

comprise each Unit Group. This list describes the individual assets and

indicates the cost basis of the asset as determined in the study.

 An example of a Unit Group is “Kitchen Equipment - Plumbing”

(which is made up of a group of individual assets). For this Unit

Group, the Property Unit Detail would list the individual assets (for

example floor drain, grease trap, sanitary piping, sink, water supply

piping, etc.) that make up the “Kitchen Equipment – Plumbing” Unit

Group and provide the cost basis of each of the individual assets as

determined in the cost segregation study.

o Abbreviated methodologies may not classify assets into Unit Groups, Property

Unit Summary or Property Unit Detail. Nevertheless, assets should be

identified, supported, and documented in a cost segregation report.

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2. Verify the Cost Basis and Reconcile Depreciation Records

Cost Segregation Studies are used to classify taxpayer assets into shorter recovery periods

to accelerate the depreciation deductions for the assets. The study results should be easily

reconcilable to the taxpayer’s depreciation or fixed asset schedules.

Examiners should reconcile the cost basis of property in a study to the cost basis contained

in the taxpayer's books and records.

• Request Detailed (Asset-by-Asset) Depreciation Schedules that tie to the tax

return. Determine how the study assets are shown on the depreciation schedules.

• Review Tax Depreciation Schedules to verify that tax basis reconciles with the

study and note any differences. Are fixtures, furnishings and equipment included in

the study? Are they located on other depreciation or fixed asset schedules? Have

these costs been duplicated?

• Request Prior Year Tax Depreciation Schedules that correspond to the study’s

assets. Do these schedules reconcile to depreciation for prior year returns? Property

reclassified to a shorter recovery period must be depreciated using the proper

method pursuant to IRC § 168(b). For example, if straight-line depreciation was used

for other property placed in service for a given recovery period during the same year

that the reclassified assets were placed in service, then § 168(b)(3) requires that the

reclassified assets must also be depreciated using the straight-line method. The

election to use straight-line depreciation is irrevocable pursuant to § 168(b)(5).

3. Conduct A Risk Analysis to Evaluate Audit Potential

Conduct a risk analysis to evaluate the audit potential and determine audit scope.

• Review the descriptions in the Property Unit Detail schedule to determine the

type of property in each unit (or group).

• Review the individual assets in each Property Unit Detail schedule. Is each

asset classified properly? (The asset matrices included in Chapter 7 can be of great

assistance in this review.)

• Compare the Study’s Property Descriptions and Classifications to Revenue

Procedure 87-56, 1987-2 C.B. 674. Is the property included in the proper Asset

Class? Are there any deviations that may indicate a potential audit issue? Identify

specific assets that might need to be viewed during a tour of the facility.

Common situations suggesting audit potential include:

o Mixed asset types in the same unit (or group). (i.e., assets with different recovery

periods).

o Building structural components or leasehold improvements classified with

improper shorter-lived § 1245 recovery periods.

o Minimal or no dollar amounts assigned to land, non-depreciable land

improvements, building, or other longer-lived assets.

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o Use of “creative” nomenclature, inconsistent titles and/or descriptions to disguise

the true character of an asset. All asset descriptions should be clear and

understandable. Does the nomenclature used for assets in the study agree with

the nomenclature used in the construction records and documents?

• Request Additional Information (as needed) to determine audit potential. In some

cases, it may be more appropriate and efficient for the preparer of the study to

respond to the document requests. Supporting documents may include computer

files, hardcopy files, plans, etc. A CAS can assist in viewing computer files not

ordinarily viewable on IRS computers.

o Issue IDRs to determine the classification of items not readily understood or that

are described in the report using an ambiguous description. Refer to Special

Topics Chapter 6.G – Information Document Requests for suggested language.

o Request contemporaneous records (permits, design studies, contractor payment

records, AIA payment documents such as G702 and G703, contracts, purchase

orders, invoices) to verify the costs and descriptions of property as well as to

ascertain their functional use. This will facilitate the determination of the proper

asset classification pursuant to Revenue Procedure 87-56. For example,

machinery located in a chemical plant is 5-year property instead of 7-year

property if it meets the requirements of Asset Class 28.0 (refer to Special Topics

Chapter 6.C – Depreciation Overview for information on asset classes).

o Request project information, such as the Capital Expenditure Request (CER) or

Authorization for Expenditure (AFE), to verify project costs and identify related

purchases. This information may also help determine the intended use of the

property.

• Summarize Your Preliminary Findings. Determine the tax impact of potential audit

issues, such as:

o Assets with a cost basis that is questionable, disputed, or unsubstantiated.

o Assets that have been misclassified and given an improper recovery period.

o Double deductions for separately acquired assets.

o The use of improper depreciation methods.

o Incorrect placed-in-service dates.

o Large look-back computations (i.e., the study reflects a change in method of

accounting, with the return reflecting a deduction for depreciation not deducted in

prior years).

• Determine the Need for Specialists (e.g., Engineers and/or Computer Audit).

Specialists may be required to assist in the examination of complex projects. It is

important that specialists be involved in the audit as early as possible. Informal

assistance may also be requested when needed.

o A study with significant tax impact generally requires the assistance of specialists.

These studies will typically have a large number of assets, or complex assets.

o A study that allocates estimated costs between § 1245 and § 1250 property

(particularly electrical or plumbing component systems) typically requires the

assistance of an engineer who is experienced in construction and construction

estimating. Engineers can provide the expertise needed for the proper

development and resolution of the issue.

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o Studies involving numerous assets or allocations may require the assistance of a

CAS to process the data and/or evaluate any statistical sampling methods.

• Determine the Scope and Depth of Your Examination. Risk analysis is a

subjective process based on the experience, knowledge, and judgment of the

examiner. Guidelines provided in the previous chapters will assist examiners in

evaluating the overall accuracy and adequacy of a study as well as in determining

audit potential and scope. Studies with little tax impact should be closed

expeditiously. Studies with significant tax impact may require specialist assistance

and should be considered for additional review and examination.

2. Examination

The examination of the cost segregation issue should proceed if the Risk Analysis identifies

audit potential due to the asset classifications in the study, and required materiality

thresholds of the specific examination are met.

4. Review the Cost Segregation Study Report for Examination Purposes

• Request a copy of the Cost Segregation Study Report, if not previously done for

the Risk Analysis. Refer to the IDR Exhibits in Special Topics Chapter 6.G –

Information Document Requests for suggested language.

• Request a copy of the Letter of Engagement to determine the scope of the study.

• Determine the Nature of the Fee Arrangement.

o Many firms charge a fee based primarily on the size of the project. Out-of-pocket

expenditures are generally added to this cost.

o Some firms use contingency fees where cost is based primarily on the tax

benefits received from a study. Contingency fee arrangements create the

incentive to maximize § 1245 costs, usually through "aggressive" legal

interpretations and/or by inappropriate cost or estimation techniques. Accordingly,

examiners should closely scrutinize studies performed on contingency fees. Refer

to Circular 230.

• Evaluate the Study with respect to its depth, accuracy and methodology and

consider the following questions: What methodology was used (see Chapter 3 –

Cost Segregation Approaches)? How does the study and report compare to the

quality elements described in Chapter 4 – Principal Elements of a Quality Cost

Segregation Study and Report?

• Determine the Cost Allocation Process used in the Study and the Source of any

Unit Costs. The following questions may assist in determining the Cost Allocation

Process: How were costs allocated? Were actual costs or estimates used? How were

unit costs determined?

• Request Contemporaneous Documentation to Substantiate and Verify the Cost

Basis of Assets.

• Determine Whether Cost Basis was Properly Allocated to land, non-depreciable

land improvements (clearing, grubbing, general land grading) and/or other property

types aside from those considered by the study.

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o Consider if any project costs were allocated to land or land improvements. Many

studies allocate almost all costs to building and personal property, instead of

allocating appropriate amounts to land, land improvements or other long-lived

assets. In the case of acquired property, it is often appropriate to assign a large

portion of an acquisition price to land prior to allocating the remaining purchase

price to other property. See “Allocating Purchase Price of Acquired Property” later

in this chapter.

5. Interview the Cost Segregation Study Preparer

An interview with the preparer of the cost segregation study is an efficient way to obtain

detail regarding the methodology used for the study as well as answers on the classification

of questionable assets and the reasoning behind those classifications.

• Schedule an Interview with the Preparer. If possible, this should be completed

before or contemporaneous with the on-site inspection. The interview should address

the scope and assumptions of the study and any observations of the project or

facilities. Possible interview questions include:

o Were the properties inspected at the time of the study?

o Were photographs and/or video media taken and/or relied upon in classifying

property?

o Were sampling techniques used?

o What cost estimating guides were used? Where are the guides located (for

purposes of verifying estimates)?

o What documentation was used to establish the cost basis and particular use of a

property item?

o How was the cost of each property item identified, segregated, and classified?

o Where are the supporting workpapers located?

6. Inspect the Property

In some instances, the only way to resolve a question regarding the proper classification of

an asset is to actually inspect the asset as installed in the taxpayer’s facility. An inspection

can provide information to the examiner on the purpose and use of an asset as well as

details of the installation and construction of the asset.

In general, the Service Engineer (if assigned) is responsible for arranging the on-site

inspection, which provides the opportunity to view the assets in question. Inspections also

help identify underground utilities, off-site improvements and general grading costs that

may have been misclassified as § 1245 or § 1250 property. Overall, the inspection provides

information to assist in determining classifications of § 1245 and § 1250 property.

• Prior to Scheduling the Tour, Complete your Review of the Study to identify

specific assets and concerns that require inspection.

• Prepare a List of Assets/Items that Warrant Inspection and provide it to the

taxpayer beforehand. Ask additional questions and/or view additional property

components during the tour as needed.

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• Plan the Inspection to Minimize Time and Travel Costs. For cases involving

multiple properties of similar character, consider inspecting only a representative

number of properties or facilities.

• Take a Camera or Video Recorder (Camcorder) to record the condition of the

property. Confirm beforehand that photography will be permitted.

• Request that the Property Manager/Maintenance Engineer be Available During

the Tour. It is important that someone familiar with the physical attributes and

workings of the property be available to answer questions and provide access to non-

public areas.

• Request that the Preparer Attend the Tour. The preparer should be able to identify

the physical attributes of specific assets and explain how they were classified.

• Request Access to Plans, Drawings and Contract Documents that are located

on-site.

• Prepare an IDR in duplicate so that any requested items received during the

inspection can be noted and an acknowledgement copy of the IDR can be left with

the taxpayer.

• View the Project Site and Document Features that impact the cost allocations and

property classifications. Consider the following points:

o Location - Record the address and locate it on a map for future reference. What is

the character of the neighborhood and how does the location impact land value?

Is there any other property for sale in the area? Note the real estate company

name and the address of the property for future reference.

o Topography - Observe the topography and determine whether the land was

initially hilly or low-lying. Did the project include the general grading of the land?

Were large amounts of fill required in order to build?

o Site Conditions - Determine whether the project included the subdividing or

rezoning of land. Did it require environmental or land use permits, or the

construction of access roads? Were off-site improvements (e.g., streets,

sidewalks, sewers, storm drains) constructed? Were any of these improvements

dedicated to the local municipality?

o Condition of Property - Is the property new or old, worn or renovated? Were the

materials modern or old?

o Project Records – Where are the original project records (e.g., drawing, plans,

contracts, payment records) located? Ask for the names of the employees who

may have particular knowledge of the construction. Request interviews with such

individuals as needed.

o Individual Assets - View each challenged asset to gain a thorough understanding

of the facts and circumstances that affect its classification and cost. Ask the site

manager how the facility is used and how individual assets operate.

 Cost Data - Discuss the methodology that was used to determine the cost

of assets. Were standard cost guides used to estimate costs? Ask on-site

maintenance and facility operations personnel about local construction and

repair costs to verify the estimated costs in the study.

• Prepare Notes and Drawings for future reference.

o Obtain sufficient information to properly classify each challenged asset.

o When possible, obtain local cost data to verify estimates and cost allocations.

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7. Review and Verify the Asset Classes and Recovery Periods of Property

A major goal of a Cost Segregation Study examination is to verify the proper classifications

and recovery periods of the assets included in the study.

Review the study again to determine whether the property classifications assigned to the

assets in the study are correct. This review is done in greater detail than the initial review

performed for risk analysis purposes. The goal is to verify the proper recovery period of all

assets and to identify possible land or non-depreciable land improvements classified as

depreciable property in the study. As in the initial risk analysis review, the property matrices

in Chapter 7 can be of great assistance in this detailed review.

• Are Assets Classified into Proper Groups according to Asset Class or

Recovery Period? Consider the following assets:

o Land

o Non-Depreciable Land Improvements (i.e., non-recurring land preparation costs

such as general land shaping and grading)

o Depreciable Land Improvements

o Buildings, Structural Components and Other § 1250 Property

o Office Furniture, Fixtures and Equipment

o Information Systems

o Building Systems (e.g., mechanical, electrical, plumbing)

o Process Systems (e.g., process piping)

o Non-Residential Real Property

o Other Miscellaneous Property

• Are Assets Assigned to the Proper Asset Class and Recovery Period?

o The classification of assets as either § 1245 or § 1250 property is a factually

intensive determination with no bright line tests.

 List Assets into the Proper Asset Class and Recovery Period.

 Refer to Chapter 2 – Legal Framework, and to Special Topics Chapter 6.D

– Relevant Court Cases for a summary of the pertinent law and judicial

precedent with respect to the classification of property.

 Recovery periods are either specifically assigned by statute (§ 168 and the

Regulations thereunder) or are determined pursuant to Rev. Proc. 87-56,

1987-2 C.B. 674. Refer to Special Topics Chapter 6.C – Depreciation

Overview, for further information on recovery periods.

o Common Audit Issues

A common issue is the allocation of specific components or portions of a building system to

§ 1245 property. The issue often arises as a result of poor documentation and/or improper

legal support.

 Example 1

Some studies may include a specific component of a building's electrical system (e.g., plug

outlet, switch, branch circuit) as being allocable to the piece of tangible personal property

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that it supports (e.g., dishwasher, garbage disposal, etc.). Accordingly, the component item

is treated as § 1245 property (e.g., 7-year MACRS). However, if that same electrical

component item can be used for other pieces of equipment, the Service examiner may

consider it to be part of the building’s general electrical system. Accordingly, it would then

be classified as part of the building as § 1250 property (39-year MACRS).

 Example 2

Some studies allocate a portion of the primary electrical feeder circuit that carries electricity

to one specific item of equipment or machinery as § 1245 property. The use of a "standard"

percentage of electrical costs is a common approach. However, in the Service’s view, these

types of allocations should be based on usage or load studies designed to ascertain the

percentage of electricity allocable to specific § 1245 property (as opposed to supporting the

general function or maintenance of the building). Examiners can also check whether a

company was reimbursed for the sales tax paid on electricity used in manufacturing; this

information may provide insight as to the correct percentage. In summary, the examiner

should conduct an in-depth analysis of the allocation and supporting documentation when a

standard percentage is used. Refer to Chapter 8.A for a discussion of the proper

methodology for the functional allocation of an electrical distribution system.

 Example 3

Some taxpayers have filed claims based on cost segregation studies of leased property.

Typically, leases were assigned to 39-year recovery property on the originally filed tax

returns. Subsequently, the taxpayer redetermines its allowable depreciation on the basis

that the acquisition was for goodwill rather than for the lease. The benefit is a potential 15-

year amortization of goodwill pursuant to § 197 (if the acquisition otherwise qualifies under

§ 197). Examiners should closely scrutinize allocations of this type.

8. Research the Law, The Regulations and Appropriate Rulings

Before reaching a final conclusion on the classification of a specific asset, the examiner

should have conducted all the necessary research and reviewed all the relevant court

cases, rulings and regulations that relate to asset classification and the challenged asset.

While some assets may, at first glance, appear to be building-related, there may be

revenue rulings or court cases that have concluded that these assets are instead tangible

personal property (e.g., electrical wiring, HVAC, decorative millwork).

Special Topics Chapter 6.D – Relevant Court Cases contains a summary of pertinent court

cases that relate to the classification of property for depreciation purposes. The examiner

should read and study these cases for guidance. An examiner must also recognize that the

determination of class life for a particular asset is factually intensive and that the

determination may vary with a particular industry and/or with the specific use by the

taxpayer.

Industry-specific guidance is included in Chapter 7.A (Casinos), Chapter 7.B (Restaurants),

Chapter 7.C (Retail), Chapter 7.D (Biotechnology and Pharmaceutical), Chapter 7.E (Auto

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Dealerships), and Chapter 7.F (Auto Manufacturing). It is anticipated that specific guidance

for additional industries will be developed in the future, and will be added to Industry

Specific Guidance Chapter 7 as it becomes available.

9. Cost Analysis

Once the proper classifications and recovery periods for the assets have been established,

the next step, if required, is to perform a Cost Analysis. In a Cost Analysis, the examiner

considers how the study allocated the project construction costs to the individual assets,

evaluates whether the allocation was performed properly, and determines whether the cost

basis of the assets as shown in the study is correct.

The methodology used for the Cost Analysis depends on whether the assets are part of a

newly constructed facility or are part of an existing facility that was acquired by the

taxpayer. The difference in Cost Analysis methodologies between these two situations is

due to the different methods used to perform studies for these properties. Actual

construction cost information is nearly always available for Newly Constructed properties;

however, it is rarely available for acquired properties. Property appraisal approaches and

construction cost estimating techniques are often used to determine the construction costs

for acquired properties.

To properly perform a Cost Analysis, knowledge of construction and construction

estimation is required and will most often involve the assistance of a Service Engineer.

Because performing a Cost Analysis is also very time consuming, they should only be

completed if there are significant questions regarding the proper basis amounts assigned to

the assets on the study.

If a cost analysis is required, see Step 12 below.

10. Summarize the Findings and Discuss the Challenged Assets with The Taxpayer

If the preliminary conclusion is that the taxpayer has misclassified certain assets, the

examiner should meet with the taxpayer as soon as practical to discuss his/her findings and

the reasoning behind them. This discussion may clear up any misunderstandings and

disagreements as to the facts and may provide an opportunity to resolve the issue.

11. Prepare the Final Report or The Notice of Proposed Adjustments (if necessary)

At the conclusion of the examination, the examiner (Revenue Agent and/or Specialist)

should prepare and issue a final report. The regulations under §1.168(i)-7 allow a taxpayer

to account for its MACRS property by treating each asset as being in a Single Asset

Account (SAA) or by combining two or more asset in a Multiple Asset Account (MAA).

Make the necessary adjustments to the basis of each asset affected by the cost

segregation study, or to the basis of each multiple asset account (MAA) affected in which

the taxpayer established an MAA, rather than making adjustments in a contra account.

The record keeping rules under Treas. Reg. § 1.167(a)-7(c) require the adjustment on an

asset-by-asset (or MAA-by-MAA) basis. This is especially important since the issuance of

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the 2014 IRC § 168 disposition regulations. See the Capitalization of Tangible Property

ATG for more information about accounting for, and dispositions of, MACRS property.

Specialists should consider having the examiner calculate the depreciation or amortization

adjustments to ensure that all pertinent factors are included in the computation.

Adjustments to the construction period interest may also be applicable. Consider if

proposed adjustments should be treated as a Service initiated change in accounting

method and, if so, follow the guidance in Rev. Proc. 2002-18. The Methods of Accounting

and Timing Practice Network is available to assist Examiners with the method changes.

3. Other Considerations

Depending on the methodology used for the cost segregation study, the type of indirect

costs that were part of the construction, and whether the study is changing the

classification of existing assets, the following steps should be considered as part of the

examination.

12. Perform A Cost Analysis

A. Cost Analysis of Newly-Constructed Property

Actual cost records should be available for Newly-Constructed Properties. This information

can most likely be obtained from the cost segregation study preparer, the taxpayer, the

project architect, the project construction manager, or the general contractor. Cost records

should be requested for significant property items only. Significant in this situation is

defined based on the materiality amounts of the specific examination.

• Gather Background Information.

o Secure total project costs by requesting information related to the construction

project billings.

o Review construction drawings and specifications.

 Construction drawings and specifications identify property items,

construction methods and locations of items within the structure.

 Review the record drawings (often called “as-built” drawings) if they are

available. Record drawings are prepared at the end of the construction

project and incorporate all changes to the original building design made

during construction, so they represent a record of what was actually

constructed. These drawings are generally available from the taxpayer, the

project architect, the project general contractor or the construction

manager. Other possible sources include the local building department,

local fire department or the taxpayer’s insurance carrier. Review the most

“up-to-date” drawings as well. These drawings include the latest revisions

made by the architect and engineers and are typically found in the

taxpayer’s facilities engineering or maintenance departments or the

property manager’s office depending on the type of facility.

o Request copies of the building permit and certificate of occupancy (C of O), which

can assist in establishing the construction start date and the placed in service

date.

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o Request photographs of the site showing the condition of the property before the

project began. This will help determine whether significant site preparation or

general grading costs were incurred.

• Request Contemporaneous Records to Substantiate the Cost Basis of Assets

in the Study.

o Contract documents specify how payments are made and typically require

payment requests to be broken down into individual items of property. Refer to

Special Topics Chapter 6.F on the Construction Process for a discussion of how

payments to contractors and suppliers are made and documented in a typical

building construction project.

o For purchases made outside the construction contract (i.e., furniture or

equipment) or for indirect costs (i.e. architectural/engineering fees, plan review

fees, etc.), purchase orders and invoices are a good source of cost data.

• Analyze the Total Project Costs.

o Review the General Contractor’s and major Subcontractor Requests for Payment

(i.e.. AIA G702 and G703). Particular attention should be made to the final pay

applications, as these should be more indicative of the final total construction

cost.

o Review any construction costs that may not be shown on the pay applications,

including change orders, indirect costs and out-of-pocket costs. Test for

completeness by looking for any missing elements (e.g., land shaping costs may

be in a separate contract).

o Review invoices for any pre-purchased or owner-furnished equipment. On large

construction projects, the taxpayer may separately pre-purchase items that have

a long delivery time (e.g., large capacity electrical sub-stations or transformers) or

may directly purchase large equipment items such as air handling units to avoid

the contractor markup. The contractor may also install owner-furnished

equipment. The examiner should verify if any pre-purchased owner-furnished

equipment is included in the total project cost and that the cost of such equipment

is treated appropriately.

• Reconcile Total Project Costs in the Taxpayer's Records with the Total Project

Costs in the Study.

o Request a copy of the taxpayer's general ledger data to support the fixed asset

amounts on the depreciation schedule. How does it compare to the amounts

shown in the study?

 Typically, the property unit numbers or reference numbers found in a study

do not track the taxpayer's accounting entries. Find out what sources the

preparer used in preparing the study.

 Verify that the total project cost in the study reconciles to the total cost

basis of assets in the taxpayer's books and records. The examiner is in the

best position to do this since he/she is the most familiar with the taxpayer’s

accounting methods. The examiner will also know where to look for other

costs that should be in the building account, but may have been expensed

or otherwise entered improperly into another account.

o Compare all data with the contemporaneous cost records.

o List any unsupported basis for potential disallowance.

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• Reconcile Detailed Cost Breakdowns to individual property elements.

o Actual cost records should be used whenever possible.

o Review the taxpayer's internal "Job Cost Reports." Typically, a preparer relies on

these documents to derive the unit costs (assuming that the cost and description

of the assets in the Job Cost Reports are accurate).

 The study methodology should be disclosed in the Assumptions and

Limiting Conditions section of the report.

 A careful analysis of the Job Cost Reports may yield significant audit

adjustments. The following is an example illustrating how the taxpayer

does not always properly classify items that are listed in this report.

 Example: The Job Cost Report includes a code for Furniture and Fixtures.

Within this code are multiple records of vendors from whom the taxpayer

claimed to have purchased items, such as furniture and fixtures. The

preparer included the total cost as § 1245 property and listed it in the study

as "FF&E." However, upon requesting contracts for each of the vendors

under this heading, the Service examiner discovered that some of these

assets were actually § 1250 property and, therefore, concluded that these

costs were erroneously included in "FF&E." Therefore, it is important that

the examiner review the vendor contracts in the Job Cost Reports,

especially those that detail the “Description of Work”, to verify asset costs.

• Prepare a List of Items/Costs that are Not Properly Substantiated.

• Compute the Correct Costs (as necessary) for individual items or groups of

property.

• Review the Cost Segregation Study Report Again.

o Review the study for its style and order of presentation. The narrative typically

describes the order of the development of costs and the spreadsheets show the

analysis and sequence.

o Review the study’s conclusions, recommendations, assumptions and limiting

conditions.

o Verify that the assumptions and limiting conditions are consistent with the facts

developed from the inspection and the review of the drawings and specifications.

• Analyze How the Detailed Cost Breakdown was Prepared.

o Review Direct Costs.

 Confirm that the direct costs are properly classified as either § 1250 or §

1245 property and identify any questionable items for further review.

o Review Indirect Costs.

 Ensure that indirect costs are properly allocated to their respective assets.

 Indirect costs generally relate to the land, certain land improvements,

and/or the building or other structures. Indirect costs generally do not relate

to the placement of machinery or furniture and fixtures. However, there are

exceptions, such as for the design of a manufacturing line. Refer to

Chapter 4 – Principle Elements of a Qualified Cost Segregation Study and

Report, for additional discussion of indirect costs.

 Studies often use large spreadsheets and sophisticated formulas to

compute the allocation of indirect costs (generally on a pro-rata basis). The

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examiner should verify any formula by testing the allocations of indirect

costs to ensure they do not exceed the total indirect costs.

• Identify Potential Audit Issues.

o Site Preparation, General Grading and Land Shaping Costs

 Building and facility projects often require general grading, site preparation

and other costs to make the site suitable for a proposed use. These costs,

along with costs for stripping existing forest and vegetation (called clearing

and grubbing) in addition to grading and compaction to provide a level site,

are generally non-depreciable costs allocable to the basis of the land. A

study may exclude these costs as being outside the scope of its work. In

other instances, a study may argue that none of these costs are allocable

to non-depreciable land improvements. Whether these types of costs are

included in the study or not, the examiner should determine all land

preparation costs included in the project, analyze them and allocate them

to non-depreciable land improvements, building, and/or depreciable land

improvements. Before-and-after photographs may help with this

determination. Also, the examiner should inspect the taxpayer's books and

records to determine how these items were treated for both financial and

tax purposes.

o § 1245 Property – Did the Study Utilize Cost Estimates or Actual Cost Records?

 Review the § 1245 and § 1250 property listings and identify the most

significant items. The examiner should check the contractor payment

records (e.g., AIA Form G-702) to see if actual costs of these items were

used in the study or whether these item costs were based on some sort of

allocation or estimate.

 For example, if the Form G-702 shows $1.2 million for the "electrical"

division work and the study shows or allocates $1.8 million to

specialized § 1245 electrical equipment, then there may be a

problem with the study’s cost determination. In this case, the

examiner should request additional information to determine the

source of the $1.8 million allocation. Note that this is only a quick

check since additional equipment or other property purchased by the

taxpayer outside the construction contract may significantly affect

this type of comparison.

o Potential Problems with Residual Methods.

 When a residual approach has been used, the examiner must be

especially careful when reviewing § 1245 property costs. In essence, this

method estimates the § 1245 property costs and then simply assigns the

remaining portion of the total cost to § 1250 property. In general, the §

1250 residual cost is neither estimated nor checked for reasonableness.

Often the result of this procedure is that the § 1245 property cost is too

high and the § 1250 property cost is too low.

 Cost estimates can also be manipulated to produce unreasonably high

estimates for § 1245 property. This is because there are a wide variety of

cost data publications that may be used, and some of these have

relatively high estimates for costs.

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 Most data sources have a higher cost for installing only one unit (e.g., a

single electrical outlet) as opposed to installing 10 or 100 units.

Economies of scale, "Quantity discounts" and competitive bidding may

significantly reduce the actual unit cost. Accordingly, estimates for multiple

units based on a single unit cost may be incorrect. The following is an

example of this problem.

 Assume that 500 of the 120-volt electrical outlets (duplex

receptacle) in a particular building have been determined to qualify

as § 1245 property. The R. S. Means Database, 2003 Edition, page

464, line 4015, lists a total price of $34.50 per 120-volt duplex

receptacle. Based on this data, a study may estimate that the 500

outlets have a total installed cost of $17,250 (500 x $34.50).

However, this estimate should be reviewed or compared with the

contractor’s actual price to determine its validity. When the taxpayer

awarded the contract, the contractor submitted a schedule of cost

for each item of work, such as for plumbing, electrical, heating, and

site work (Forms G-702 and G-703). The examiner should review

Forms G-702 and G-703 to determine the cost that the contractor

assigned to the electrical work. If the Form G-703 indicates that

$120,000 was assigned to electrical receptacles and there were

5530 receptacles to install, then the actual unit cost to install each

receptacle is only $ 21.70 per outlet. The total actual cost for the

500 outlets is therefore only $10,850 (500 x $21.70). The total actual

cost compared to the estimated cost ($17,250) may result in a

significant difference. Note that cost estimates based on either the

R. S. Means data or on the contractor's actual costs would need to

be increased by any applicable indirect costs.

o Potential Problems with “Rule of Thumb” Methods

A. While the documentation of costs drawn from the use of a "rule of thumb"

method is typically sketchy and inadequate, the examiner should not

categorically reject a study involving the use of "rule of thumb." The

documentation needs to be examined and verified on its own merits to

determine if cost recovery properties are accurately identified and placed

into proper recovery periods.

B. Cost Analysis of Existing or Acquired Property

Allocating Purchase Price of Acquired Property

Cost segregation is applied both to determine the classification of property and to allocate

the cost basis of property. This section focuses on cost segregation studies involved in

allocating cost basis when acquiring a group of assets. Such allocations generally must rely

on determining the fair market values of the acquired assets.

In this audit technique guide, new property and particularly new building construction

projects receive much attention in the chapters addressing cost segregation studies and

reports. However, cost segregation is not limited to Newly-Constructed property. Cost

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segregation also applies to the acquisition of a group of assets often acquired for a lump

sum, such as real estate or a trade or business. Approaches for segregating newly

constructed property rely on contemporaneously billed and itemized costs, published costs

of new property, or other estimated costs new. To determine the fair market values of the

acquired assets, appraisal practices and procedures must be relied on to

allocate/segregate a lump sum basis.

In the case of an acquisition including a combination of depreciable and non-depreciable

property for a lump sum (e.g., buildings and land), the basis for depreciation cannot exceed

an amount which bears the same proportion to the lump sum as the value of the

depreciable property at the time of acquisition bears to the value of the entire property at

that time; Treas. Reg. § 1.167(a)–5, apportionment of basis. The relevant inquiry is the fair

market values of the properties at the time of acquisition. Whether an opinion of value is

provided in a report styled as a cost segregation study or an appraisal report, any opinion

of value should be developed and reported by appropriate standards of the professional

appraisal practice.

Examiners should consider seeking the expertise of IRS Engineers and Appraisers when

examining value and allocation issues.

Real Estate Allocations

In allocating, a lump sum price paid for real estate, appropriate appraisal practices and

procedures must be applied to determine the fair market values of the non-depreciable land

and each of the depreciable assets (buildings, land improvements and personal property).

The cost segregation study should explain the standard of value that is applied. When

performing a risk analysis of a cost segregation study, examiners should also consider

whether value opinions were provided by a competent and qualified appraiser.

The fair market value of land should be based on the highest and best use of the land as

though vacant, even if the land has improvements. The land value may equal the value of

the total real estate even if the real estate has substantial improvements, when such

improvements do not contribute value to the property. Whereas land has value,

improvements contribute value. The value of the total real estate, less the value of the land,

results in the value of the improvements. Accordingly, it is inappropriate to estimate the

value of the land by subtracting the estimated value of the improvements from the lump real

estate price. Basis assigned to land in this residual fashion may result in understating the

appropriate basis in the land and overstating the appropriate basis in the depreciable

improvements. Examiners should also be wary if a cost segregation study relies solely on

local assessed values rather than appropriately determining fair market values.

Section 1060 Allocations

Section 1060 prescribes special allocation rules for determining a transferee’s (buyer’s)

basis and a transferor’s (seller’s) gain or loss in an applicable asset acquisition. An

applicable asset acquisition is any transfer of assets (either directly or indirectly) that

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constitutes a trade or business and with respect to which the purchaser’s basis in such

assets is determined wholly by reference to the consideration paid for them. See § 1060(c).

A group of assets constitutes a trade or business if i) the use of the assets would constitute

an active trade or business under § 355 or, ii) its character is such that goodwill or going

concern value could under any circumstances attach to such group of assets. See Treas.

Reg. § 1.1060-1(b)(2).

The Omnibus Budget Reconciliation Act of 1990 amended § 1060(a) to provide that where

the parties to an applicable asset acquisition agree in writing as to the allocation of any

amount of consideration, or as to the fair market value of any of the assets transferred, that

agreement is “binding” on the transferee and the transferor unless the Commissioner

determines that the allocation (or fair market value) is not appropriate. See § 1060(a)(2).

The House Report accompanying the amendment to § 1060(a) explained that:

“… a written agreement regarding the allocation of consideration to, or the fair market

value of, any of the assets in an applicable asset acquisition will be binding on both

parties for tax purposes, unless the parties are able to refute the allocation or valuation

under the standards set forth in the Danielson case. The parties are bound only with

respect to the allocations or valuations actually provided in the agreement. * * *

The committee does not intend to restrict in any way the ability of the Internal

Revenue Service to challenge the taxpayers’ allocation to any asset or to challenge the

taxpayers’ determination of the fair market value of any asset by any appropriate

method, particularly where there is a lack of adverse tax interests between the parties.

See H. Rept. 101-881, at 351 (1990).”

In Commissioner v. Danielson, 378 F.2d 771, 775 (3d Cir. 1967), the Court of Appeals

ruled that a taxpayer can challenge the tax consequences of a written agreement “as

construed by the Commissioner only by adducing proof which in an action between the

parties to the agreement would be admissible to alter that construction or to show its

unenforceability because of mistake, undue influence, fraud, duress, etc.” The Court of

Appeals for the Eleventh Circuit has expressly adopted the Danielson rule. See Peterson v.

Commissioner, 827 F.3d 968 (11

Cir. 2016); Plante v. Commissioner, 168 F.3d 1279,

1280-1281 (11th Cir. 1999); Bradley v. United States, 730 F.2d 718, 720 (11th Cir. 1984);

and North American Rayon Corp. v. Commissioner, 12 F.3d 583, 589 (6th Cir. 1993).

In Peco Foods, Inc. v. Commissioner, T.C. Memo. 2012-18, aff’d 522 Fed. Appx. 840 (11

Cir. 2013), the taxpayer purchased two poultry processing plants in applicable asset

acquisitions under § 1060. As part of the acquisitions, Peco Foods entered into written

agreements with the seller allocating the purchase price among the acquired assets. In

addition, Peco Foods hired an outside consulting firm to perform a cost segregation study

on the acquired plants, and subsequently filed a Form 3115 with its tax return to change its

accounting method and reclassify certain property from nonresidential real property to

tangible property. The IRS disputed these changes, arguing that the taxpayer could not

modify the purchase price allocations and subdivide them into component assets in a

manner at odds with the allocation schedules. The Tax Court held that Peco Foods was

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bound by the clear and unambiguous terms of the original allocation schedules and could

not deviate from its characterization of those assets. Thus, the taxpayer was not allowed to

change its method of accounting for the acquired assets pursuant to its cost segregation

study. It is unclear whether the holding in Peco Foods would apply to acquisitions other

than applicable asset acquisitions under § 1060.

Where the parties to an applicable asset acquisition do not agree in writing to the allocation

of consideration of the assets, § 338(b)(5) applies. In general, sellers and purchasers must

allocate the consideration under the residual method as described in Treas. Reg. §§ 1.338-

6 and 1.338-7 to determine the transferee’s basis in, and the transferor’s gain or loss from,

each of the assets transferred. See Treas. Reg. § 1.1060-1(a).

In addition to the steps previously discussed for Newly-Constructed property, the following

audit steps for existing properties should be considered.

• Review the Acquisition Documents to determine the assets purchased. Determine

whether there was a written purchase price allocation agreed to by the buyer and

seller (you may need to contact the seller). If there was an allocation between

personal and real property, then the written purchase price allocation is binding on

the taxpayer and cannot be changed by a taxpayer’s subsequent cost segregation

study. Only the Service can challenge a contract allocation. See § 1060(a);

Danielson, supra. If there was not a written price allocation, then the examiner should

address the study and go to the next step. See Peco Foods, supra.

• Review the Escrow Documents and Payment Records to substantiate the overall

purchase price.

• Ensure that the Land has been Properly Valued.

o Request a copy of the appraisal that provides the opinion of the fair market value

of the property. The appraisal should indicate the value of the land and

improvements separately. Land included in the purchase price is valued first. The

value of land should be determined at its "highest and best use." Properties tend

to appreciate based on the value of land.

o Land value should not be reduced for any pre-existing environmental

contamination because the prior owners are often held responsible for this and/or

the property is generally insured for this situation.

1. Ensure that Older Properties are Adjusted for Depreciation.

o Assets and asset groupings must be carefully reviewed and scrutinized to

determine their physical and economic condition.

o Relatively new items should be valued as new (e.g., windows, building exterior,

emergency generator).

o Older items may be physically deteriorated or functionally or economically

obsolete, and should be assigned a value commensurate with their condition or

use. For example, a building may have been pre-wired for telephones but, if it is a

"non-digital" system, it may have a low value.

• Ensure that Replacement Cost Values are Properly Adjusted for the actual

condition and remaining economic useful life of the assets.

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o The value of used components must be reduced from the replacement cost new

value in proportion to the observed economic obsolescence or physical

depreciation as compared to similar new assets. This principle is discussed in

regard to the “Helipot Building” in Lesser v. Commissioner, 42 T.C. 688 (1964),

aff’d, 352 F.2d 789 (9

Cir. 1965), acq., 1966-2 C.B. 5, cert. denied, 384 U.S. 927

(1966).

• Review the Contract Files for information regarding the original construction and

any subsequent repairs or modifications. This information should be used when

viewing the existing condition of the building to verify, if possible, that the original

contract work was performed.

o Review the Construction Drawings. The existing structure should be compared

to the record drawings (commonly called “as-built” drawings) to help identify

subsequent repairs and modifications. In many instances for an acquired

property, full construction drawings are not available or are minimal.

• Consider Demolition Expenses.

o Assets scheduled to be demolished should have no basis or value assigned to

them.

o § 280B provides that the demolition cost of any structure is a capital cost

chargeable to the land. Any abandonment losses incurred in connection with a

demolition should also be considered for capitalization to the land. See TAM

9131005 (Apr. 25, 1991).

In summary, the examiner should ensure that:

• The study methodology for the proper allocation of the purchase price between the

non-depreciable land and depreciable building and personal property must be based

upon their values as of the date of purchase.

• The value of property items must take into account the physical wear and tear of

each property item and any economic or functional obsolescence.

13. Review Sampling Techniques (If Necessary)

Taxpayers may utilize sampling techniques to minimize the time and costs associated with

performing an analysis on all the properties (refer to the discussion in Chapter 4, Cost

Segregation Methodologies). Sampling may also be utilized with cost documents. The use

of sampling adds another level of difficulty when examining these studies. The examiner

should take the following steps in reviewing a taxpayer’s sampling technique.

• Request the Assistance of Engineers and Computer Audit Specialists.

o If the taxpayer has utilized any form of sampling in a study, it is imperative that a

CAS be consulted to review the sampling method. The CAS will use Rev. Proc.

2011-42 as guidance in evaluating the adequacy of the statistical sampling

program. If needed, the CAS will request that a statistical sampling coordinator be

assigned to specifically review the sampling procedures used by the taxpayer. An

engineer can also assist in the review of strata and property groups, and the cost

allocations of property.

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o Sampling techniques may also be a useful tool for examiners when reviewing the

adequacy and accuracy of a cost segregation study. Consultation and/or referral

to a statistical sampling coordinator in the CAS Program is highly recommended

to develop a reliable and supportable sample.

• Understand the Sampling Technique.

o In situations involving large numbers of substantially identical properties, a study

may utilize sampling or estimation techniques to select specific properties on

which a "full" cost segregation study is performed. This approach, often referred

to as "modeling", is typical for retail or food chain operations, where a "cookie-

cutter" type of structure is involved.

o The taxpayer may have a limited number of "prototype" structures, such as free-

standing units, locations in strip/enclosed malls, full-service locations, carryout

units, leased properties. The population is stratified by prototype to form groups of

similar structures.

o Sampling within each prototype group is then performed with the results projected

to the entire population within that prototype. The projection of sampling results is

limited to items and years included in the original population. The results cannot

be extrapolated to years outside this population. The application of “extrapolation

with a haircut” to items or years not included in the sampled population is not

allowed for cost segregation studies.

o Adjustments made by an examiner to the cost allocation performed on a sampled

item are projected to the overall population to determine the overall adjustment.

Based on which strata the adjusted sample resides in, the adjustment to the

overall population may be significantly more than the adjustment made to the

sampled item. This should be considered when performing a risk analysis on cost

segregation studies that use statistical sampling.

• Determine/Evaluate the degree of Similarity Between Properties Within a

Group.

o The determination of the similarity between properties within a prototype group is

difficult and creates a potential area of dispute. The examiner should be aware

that while the appearance of a particular structure may be very similar to the

prototype, differences could exist.

o The rationale for stratifying properties is generally based on factors such as the

style of the structure (e.g., location in strip/enclosed mall as opposed to a free-

standing location), geographical location, and total square footage, leased, or

owned. A stratification that is based on relatively unimportant factors or irrelevant

similarities, such as the total number of windows in a structure or the total square

footage of the site, is highly suspect and generally warrants further analysis.

o Geographic variations due to physical site characteristics, climate, building codes

and union versus nonunion labor, may create a wide disparity in structure costs.

Therefore, stratification of otherwise similar properties across wide geographical

areas may not be an accurate approach. Accordingly, the methodology should be

carefully reviewed, as the "sampled" property may not be relevant to the other

properties within the strata or group.

o CAS and engineers should be involved to properly analyze and evaluate the

strata and groupings, as well as the sampling methodology.

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• Review the Sampling Methodology.

o When conducted properly, statistical sampling is a reliable technique when the

risk (sampling error) of not examining 100 percent of the properties can be

accurately determined.

o The use of a modeling technique is a reliable technique, provided the standard

models or templates are properly analyzed and are similar to their respective

groups (i.e., appropriate stratification into similar groups).

o Judgment sampling is another technique, but this technique does not rely on

statistical methodology and is highly subjective. Therefore, it warrants greater

scrutiny by the examiner.

• Potential Issues

o Improper sampling techniques (regardless of the methodology used) that do not

reflect a valid estimate.

o A relatively small number of units in the population (less than 100) can yield a

small sample size. However, small sample size can be overcome by the

application of a proper statistical sampling methodology and the utilization of the

least advantageous limit computed at a 95% one-sided confidence level.

 Simply stated, the least advantageous limit is computed as the point

estimate plus or minus the sampling error, where the result provides the

least benefit to the taxpayer.

 Many taxpayers simply use the point estimate without regard to the

sampling error, thereby ignoring the risk of error inherently associated with

sampling techniques.

o Missing records, substitution of missing items, missing documentation, and the

use of estimated costs.

o Properties that may not be appropriate for sampling (e.g., small number of

dissimilar properties).

o Inappropriate stratification of properties and faulty statistical sampling within each

stratum.

o Use of judgment sampling, which is highly subjective and thus may be of limited

value.

14. Consider § 263A

The uniform capitalization (UNICAP) rules of § 263A require the capitalization of all direct

costs and certain indirect costs properly allocable to real property and tangible personal

property produced by the taxpayer. Self-constructed assets and property built under

contract are treated as property “produced” by the taxpayer. Therefore, changes to the

class life or basis of an asset may require a concurrent adjustment of UNICAP costs.

Furthermore, § 263A(f) requires the capitalization of certain interest expenses incurred in

connection with the production of property. The interest capitalization rules under Treas.

Reg. § 1.263A-8 contain precise definitions of designated property and include inherently

permanent structures in the definition of real property. In summary, all real property and

certain tangible personal property are subject to the interest capitalization rules. Therefore,

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changes to real and tangible personal property costs may impact the amount of capitalized

interest.

Taxpayers may attempt to exclude all § 1245 property from interest capitalization by

arguing that § 1245 property is tangible personal property that does not meet the

classification thresholds of Treas. Reg. § 1.263A-8(b)(1). However, § 1245 property that is

an inherently permanent structure is subject to interest capitalization without any

restrictions. In general, the standard for determining whether an item of property is

inherently permanent for purposes of § 263A and § 199 is broader than the standard for

cost recovery (depreciation). For more discussion and analysis used to determine whether

an item is inherently permanent under various Code provisions, see Appendix Chapter 6.E,

“Inherently Permanent” Standard Under Various Code Sections.

For tax years beginning after December 31, 2017, a small business taxpayer is not required

to capitalize costs including interest under § 263A. A small business taxpayer is a taxpayer

that (a) has average annual gross receipts of not more than $25 million for the 3 prior tax

years (adjusted annually for inflation), and (b) is not a tax shelter as defined in § 448(d)(3).

Ideally, a taxpayer’s books and records should consider and comment on the treatment of

UNICAP when amounts are restated for prior tax years based on a cost segregation study.

Refer to Special Topics Chapter 6.A – Uniform Capitalization for a summary of the major

provisions of § 263A. Specific questions regarding § 263A can be referred to the Inventory

& 263A Practice Network.

15. Consider Change in Accounting Method

In general, it is the position of the Service that a change in an adopted depreciation

method, recovery period or convention for depreciable property resulting from the

reclassification of property is a change in accounting method. Such a change requires the

consent of the Commissioner (i.e., the taxpayer must generally file a Form 3115,

Application for Change in Accounting Method) and the adjustment to taxable income is

made pursuant to § 481(a). Accordingly, claims for adjustment to a taxpayer’s adopted

depreciation method based on a cost segregation study performed after the original return

was filed should not be allowed. Instead, the taxpayer should use the voluntary method

change procedures provided in Rev. Proc. 2015-13 (or successor) to change its

depreciation method on a prospective basis by filing a Form 3115. See IRM 4.11.6.

Some of the more common issues encountered in this area include:

• Use of incorrect revenue procedure for implementing change in accounting method

(i.e., use of automatic change procedures instead of non-automatic change

procedures);

• Terms of applicable revenue procedure(s) not properly applied;

• Change is not made to a permissible method;

• Form 3115 is not filed;

• Taxpayers want to add items to the original Form 3115, as filed;

• Lack of records to substantiate the § 481(a) adjustment;

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• Informal claims filed in lieu of Form 3115;

• Informal claims filed prior to preparation of cost segregation study;

• Lack of detail to determine basis and recovery periods.

Prior to the issuance of final regulations under IRC 446(e), the issue of whether a change in

depreciation method, convention, or recovery period constitutes a change in accounting

method was unsettled due to conflicting court opinions. However, Treas. Reg. § 1.446-

1(e)(2)(ii)(d)(2)(i) and Example 9 of Treas. Reg. § 1.446-1(e)(2)(iii), effective for taxable

years ending on or after December 30, 2003, provide that each such change constitutes a

change in accounting method. Please refer to Special Topics Chapter 6.B for a more

detailed discussion on Change in Accounting Methods. You can refer specific questions

regarding change in accounting methods to the Methods of Accounting and Timing Practice

Network.

16. Penalty for Cost Seg Study Preparer:

Chief Counsel Advice CCA 201805001 determined that an engineer tax consultant was

liable for the Section 6701 penalty for aiding and abetting understatements of tax. The CCA

concluded that the engineer prepared and furnished to each client a cost segregation report

that mischaracterized components of a 39-year recovery building to a shorter recovery

period (5-year) personal property. The engineer knew that their taxpayer-client would rely

upon the determinations of the report to file their income tax returns with excessive

depreciation deductions. The IRS also concluded that the engineer knew the reports, if

relied upon, would result in understatements of tax liability. Under Code Section 6701, the

penalty is $1,000 for each individual return and $10,000 for each corporate return.

C. Summary and Conclusions

Using the steps outlined in this chapter, the Service examiner can evaluate the adequacy

and accuracy of a cost segregation study and determine the proper classification and cost

of property. The need for a specialist, such as a CAS or an Engineer, should also be

evaluated and determined as soon as possible. The guidance in this ATG is designed to

facilitate the audit process and minimize burden on taxpayers, practitioners, and examiners

alike.

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Chapter 6 Special Topics

A. Uniform Capitalization

1. Introduction

The allocation of project costs in cost segregation studies for self-constructed assets may

be impacted by the Uniform Capitalization (UNICAP) rules of § 263A(a). In addition, the

interest capitalization rules of § 263A(f) may also apply. A brief summary of these

provisions is presented below.

2. Application of the Capitalization Rules Under § 263A

The UNICAP rules require the capitalization of all direct costs and certain indirect costs

allocable to real property and tangible personal property produced by the taxpayer. For

purposes of the uniform capitalization rules, to “produce” means to construct, build, install,

manufacture, develop, improve, create, raise or grow [§ 263A(g)(1); Treas. Reg. § 1.263A-

2(a)(1)(i)]. Self-constructed assets and property built under contract are treated as property

“produced” by the taxpayer and the rules under § 263A(a) govern.

In addition, § 263A(f) requires the capitalization of interest expense when the taxpayer

produces certain property. The interest capitalization rules under Treas. Reg. § 1.263A-8

contain precise definitions of designated property and include inherently permanent

structures in the definition of real property. In summary, all real property and certain

tangible personal property are subject to the interest capitalization rules. Therefore, any

change in the allocation of costs between real and tangible personal property may have an

impact on the amount of capitalized interest. Many taxpayers attempt to exclude all § 1245

property from interest capitalization arguing that the § 1245 property is tangible personal

property that does not meet the classification thresholds of Treas. Reg. § 1.263A-8(b)(1).

Most of the § 1245 property in these situations are inherently permanent structures (real

property) subject to interest capitalization without any restrictions.

For tax years beginning after December 31, 2017, a small business taxpayer is not required

to capitalize costs including interest under § 263A. A small business taxpayer is a taxpayer

that (a) has average annual gross receipts of not more than $25 million for the 3 prior tax

years (adjusted annually for inflation), and (b) is not a tax shelter as defined in § 448(d)(3).

The following text summarizes the capitalization rules of § 263A(a) and the interest

capitalization rules of § 263A(f). Further detail and updates can be obtained from the

Inventory and § 263A Practice Network (PN). Also, §263A adjustments generally involve a

change in accounting method. Please refer to Special Topics Chapter 6.B – Change in

Accounting Method for more information.

3. Capitalization of Costs Under § 263A

How does § 263A identify the costs subject to capitalization? Any cost which (but for

§ 263A and the regulations thereunder) may not be taken into account in computing taxable

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income for any taxable year is not treated as a cost properly allocable to property produced

or acquired for resale. Thus, for example, any cost (or portion of cost) that is not deductible

is not properly allocable to property produced or acquired for resale.

In addition, any cost required to be capitalized under § 263A may not be included in

inventory or charged to capital accounts or included in basis any earlier than the taxable

year during which the amount is incurred within the meaning of § 1.446-1(c)(1)(ii).

What costs are capitalized under § 263A? Except as otherwise provided, direct costs and

all indirect costs that are properly allocable to property produced must be capitalized.

Indirect costs are properly allocable to property produced when they directly benefit or are

incurred by reason of the performance of production activities. For a producer, the direct

costs generally include direct material and direct labor. The regulations include examples of

indirect costs [see § 1.263A-1(e)(3)(ii)]. Examples of indirect costs required to be

capitalized to the extent they are properly allocable to property produced are:

• bidding costs

• capitalizable service costs (including capitalizable mixed service costs)

• cost recovery allowances (however, remember depletion is only allocated to

inventory produced and sold during the year)

• engineering and design

• employee benefit expenses

• handling costs

• indirect labor costs

• indirect material costs

• insurance

• interest (see special rules under § 263A(f))

• licensing and franchise costs

• officers' compensation

• pension and other related costs

• purchasing costs

• quality control

• rent

• repairs and maintenance

• spoilage

• storage costs

• taxes

• tools and equipment

• utilities

Producers must capitalize costs (other than interest) whether incurred before, during, or

after the production period of property. Interest is only capitalized during the production

period of property. Pre-production costs are subject to capitalization if the property is held

for future production or if it is reasonably likely that the property will be produced at a future

date. Thus, costs of storing raw materials and property taxes for real property held for

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development are required to be capitalized. Some issues may arise in determining the

taxpayer's intent and the taxpayer’s change in intent. Production period costs are costs

incurred beginning on the date on which production of the property begins and ending on

the date on which the property is ready to be placed in service or is ready to be held for

sale. Post-production costs are costs incurred after the actual production and may include

storage and handling costs incurred while holding the property produced for sale after

production.

Treas. Reg. § 1.263A-1(f) sets forth various detailed or specific cost allocation methods that

a taxpayer may use to allocate direct and indirect costs to property produced. Under Treas.

Reg. § 1.263A-1(f) a taxpayer may use a specific identification method, burden rate

method, standard cost method, or any other reasonable method to allocate costs. In

addition, in lieu of these methods, producers may use the simplified production methods

provided in Treas. Reg. §§ 1.263A-2(b) and (c).

4. Capitalization of Interest Under § 263A(f)

Treas. Reg. §§ 1.263A-8 through 1.263A-15 provides guidance with respect to the

capitalization of interest under § 263A(f). These regulations are effective for 1995 and after,

or at taxpayer's election, 1994. For years prior to the final regulations, Notice 88-99, 1988-2

C.B. 422, and temporary regulations provide guidance with respect to the capitalization of

interest.

For tax years beginning after December 31, 2017, a small business taxpayer is not required

to capitalize costs including interest under § 263A. A small business taxpayer is a taxpayer

that (a) has average annual gross receipts of not more than $25 million for the 3 prior tax

years (adjusted annually for inflation), and (b) is not a tax shelter as defined in § 448(d)(3).

Interest is capitalized with respect to each unit of designated property. Interest is

capitalized during each computation period; the amount of interest that is capitalized is a

function of:

• the amount of accumulated production expenditures;

• the amount of outstanding debt(s) on each measurement date; and

• the interest rate of the outstanding debt(s).

In determining the amount of outstanding debt, traced debt is considered first. The excess

expenditure amount is the amount (if any) by which the accumulated production

expenditures exceed the amount of traced debt. Interest on non-traced debt, up to the

excess expenditure amount, must be capitalized, based upon a weighted average interest

rate. Pursuant to Treas. Reg. § 1.263A-9(d), taxpayers may elect not to trace debt. See

Treas. Reg. § 1.263A-9.

Designated property is defined in § 263A(f)(1) and Treas. Reg. § 1.263A-8(b)(1). In

general, § 263A(f) applies to designated property. Designated property is any property that

is produced and that is:

60 | Page

1. Real property; or,

2. Tangible personal property (as defined in Treas. Reg. § 1.263A-2(a)(2)) that meets

any of the following classification thresholds:

o Property with a class life of 20 years or more that is not inventory in the hands of

the taxpayer or a related person;

o Property with an estimated production period (as defined in Treas. Reg. §

1.263A-12) exceeding 2 years; or

o Property with an estimated production period exceeding 1 year and estimated

cost of production exceeding $1,000,000.

Note: All real property is subject to the rules of § 263A(f); the classification thresholds

only apply to tangible personal property.

The classification thresholds are applied individually to each unit of property.

Treas. Reg. § 1.263A-8(c)(1) defines real property. Real property includes land, unsevered

natural products of land, buildings, and inherently permanent structures. Any interest in

real property, including fee ownership, co-ownership, a leasehold, an option, or a similar

interest is real property. Unsevered natural products of land include growing crops and

plants (that have a pre-productive period more than 2 years), mines, wells, and other

natural deposits. Real property includes the structural components of both buildings and

inherently permanent structures.

Inherently permanent structures include property that is affixed to real property and that will

ordinarily remain affixed for an indefinite time. Examples are swimming pools, roads,

bridges, tunnels, paved parking areas and other pavements, special foundations, wharves

and docks, fences, inherently permanent advertising displays, inherently permanent

outdoor lighting facilities, railroad tracks and signals, telephone poles, power generation

and transmission facilities, permanently installed telecommunications cables, broadcasting

towers, oil and gas pipelines, derricks and storage equipment, grain storage bins and silos.

For purposes of this section, affixation to real property may be accomplished by weight

alone. [Treas. Reg. § 1.263A-8(c)(3)]

Property may constitute an inherently permanent structure even though it is not classified

as a building for purposes of former § 48(a)(1)(B) and Treas. Reg. § 1.48-1. Any property

not otherwise described in Treas. Reg. § 1.263A-8(c)(3) that constitutes other tangible

property under the principles of former § 48(a)(1)(B) and Treas. Reg. § 1.48-1(d) is treated

for the purposes of Treas. Reg. § 1.263A-8 as an inherently permanent structure. [Treas.

Reg. § 1.263A-8(c)(3)]

A structure that is property in the nature of machinery or is essentially an item of machinery

or equipment is not an inherently permanent structure and is not real property. In the case,

however, of a building or inherently permanent structure that includes property in the nature

of machinery as a structural component, the property in the nature of machinery is real

property. A structure may be an inherently permanent structure, and not property in the

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nature of machinery or essentially an item of machinery, even if the structure is necessary

to operate or use, supports, or is otherwise associated with, machinery. [Treas. Reg.

1.263A-8(c)(4)]

B. Change in Accounting Method

1. Introduction

A taxpayer may conduct a cost segregation study on used property and then re-compute its

depreciation deductions for prior years. The underlying incentive for preparing these

studies for Federal income tax purposes is the significant tax benefits derived from utilizing

shorter recovery periods and accelerated depreciation methods for computing depreciation

deductions. Examiners need to be aware of the potential issues relating to these re-

computations, including the need for taxpayers to notify the Service that it intends to make

a change in accounting method for those items identified in the cost segregation study. This

chapter provides a brief overview of the applicable law in this area.

2. Historical Service Position

It has been the long-standing position of the Service that a taxpayer adopts a permissible

method of accounting in the tax year a depreciable asset is placed in service, relative to the

depreciation method, recovery period (but not useful life), or convention for the depreciable

property. A taxpayer adopts an impermissible method of accounting relative to depreciable

property when it is treated in the same way on two or more consecutively filed returns.

Once a method is adopted, a change in depreciation method, recovery period (but not

useful life), or convention resulting from a reclassification of such property, results in a

change in method of accounting. Such a change requires the consent of the Commissioner

(i.e., the taxpayer must generally file a Form 3115, Application for Change in Accounting

Method), and the adjustment to taxable income is made pursuant to § 481(a). If a taxpayer

has adopted a method of accounting, the taxpayer may not change the method by

amending its prior income tax returns. See Rev. Rul. 90-38, 1990-1 C.B. 57. Accordingly,

amended returns or claims for adjustment, based on a cost segregation study performed

after the original return was filed for the placed-in-service year and the original return for

the subsequent tax year, should generally be disallowed on the basis that the taxpayer is

attempting to make a retroactive method change. See § 446(e) and IRM 4.11.6.7.5.

The Service's historical position is that a change in computing depreciation under §§ 167,

168, or 197, or former §§ 168 (“ACRS”), 1400I, 1400L(b), or 1400L(c) generally is a change

in method of accounting under § 446(e) for which the consent of the Commissioner is

required. However, this position was successfully challenged by several taxpayers in

litigation with respect to depreciable property subject to § 168 (MACRS property). See

Brookshire Brothers Holding, Inc. & Subsidiaries v. Commissioner, 320 F.3d 507 (5th Cir.

2003), Green Forest Manufacturing Inc. v. Commissioner, T.C. Memo. 2003-75, and

O’Shaughnessy v. Commissioner, 332 F.3d 1125 (8th Cir. 2003); but contrast Kurzet v.

Commissioner, 222 F.3d 830 (10th Cir. 2000). Because of these decisions, there was

62 | Page

inconsistent treatment of taxpayers with respect to whether a change in computing

depreciation under § 168 was a change in method of accounting under § 446(e).

Final regulations under § 446(e), T.D. 9307, 71 F.R. 78066 (December 28, 2006), address

the circumstances under which a change in calculating depreciation or amortization is a

change in method of accounting under § 446(e). These regulations adopt, with

modifications, temporary regulations published in the Federal Register on January 2, 2004.

The final regulations provide that the following are changes in method of accounting under

§ 446(e):

• A change in the treatment of an asset from non-depreciable or non-amortizable to

depreciable or amortizable, or vice versa, Treas. Reg. § 1.446-1(e)(2)(ii)(d)(2)

• A correction to require depreciation in lieu of a deduction for the cost of depreciable

or amortizable assets that had been consistently treated as an expense in the year

of purchase, or vice versa, Treas. Reg. § 1.446-1(e)(2)(ii)(d)(2)

• A change in the depreciation or amortization method, period of recovery, or

convention of a depreciable or amortizable asset, Treas. Reg. §

1.446-1(e)(2)(ii)(d)(2)(i) and

• A change to or from claiming the additional first year depreciation deduction provided

by, for example, § 168(k), former § 1400L(b), or former § 1400N(d) under certain

circumstances, Treas. Reg. § 1.446-1(e)(2)(ii)(d)(2)(ii).

Treas. Reg. § 1.446-1(e)(2)(iii), Example 9, provides an illustration of a change in

accounting method due to changes in depreciation method, recovery period and

convention, all resulting from a cost segregation study.

The final regulations clarify that a change in depreciation due to a posting or mathematical

error, or a change in underlying facts, is not an accounting method change because the

rules in Treas. Reg. § 1.446-1(e)(2)(ii)(a) and (b) also apply to a depreciation change.

In addition, Treas. Reg. § 1.446-1(e)(2)(ii)(d)(3)(i) provides that an accounting method

change does not include an adjustment in the useful life of a depreciable or amortizable

asset for which depreciation is determined under § 167 (other than under § 168, former §

1400I, former § 1400L(c), former § 168, or an additional first year depreciation deduction

provision of the IRC). This rule does not apply if a taxpayer is changing to or from a useful

life (or recovery period or amortization period) that is specifically assigned by the Code,

regulations, or other guidance published in the Internal Revenue Bulletin.

Treas. Reg. § 1.446-1(e)(2)(ii)(d)(3)(iii) provides that the making of a late depreciation or

amortization election or the revocation of a timely valid depreciation or amortization election

is not a change in method of accounting, except as otherwise expressly provided by the

Code, regulations, or other guidance published in the Internal Revenue Bulletin.

Finally, Treas. Reg. § 1.446-1(e)(2)(ii)(d)(3)(v) provides that any change in the placed-in-

service date of a depreciable or amortizable asset is not treated as a change in accounting

method.

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The final regulations under § 446(e) only apply to a change in depreciation made by a

taxpayer for a depreciable or amortizable asset placed in service by the taxpayer in a tax

year ending on or after December 30, 2003, regardless of whether the change in

depreciation is a change in method of accounting.

3. Change in Litigating Position

On January 28, 2004, the Associate Chief Counsel (P&SI) issued a Change in Litigating

Position Notice (“Notice”) regarding the application of § 446(e) to changes in computing

depreciation. See Notice CC-2004-007, as clarified by Notice CC-2004-024.

The Notice provides that the Service's position continues to be that a change in computing

depreciation under §§ 167, 168, 197, former §§ 1400I, 1400L(b), or 1400L(c), or ACRS, is

a change in method of accounting under § 446(e) for which the consent of the

Commissioner is required. However, for depreciable or amortizable property that is treated

as a capital asset and placed in service in taxable years ending before December 30, 2003,

the Service will no longer litigate the issue of whether such a change in computing

depreciation is a change in method of accounting under § 446(e).

It should be noted that the change in the Service's litigating position does not apply to a

change in the treatment of property from a non-capital asset (for example, inventory,

materials and supplies) to a capital, depreciable or amortizable asset (or vice versa), or to a

change from expensing the cost of depreciable or amortizable property to capitalizing and

depreciating or amortizing such cost (or vice versa). These changes are a change in

method of accounting under § 446(e). Accordingly, examiners should consult with their

local Chief Counsel attorneys should a taxpayer assert that these changes are not a

change in method of accounting.

4. Peco Foods Case

In Peco Foods, Inc. v. Commissioner, T.C. Memo. 2012-018, aff’d 522 Fed. Appx. 840

(11th Cir. 2013), the taxpayer purchased two poultry processing plants in applicable asset

acquisitions under § 1060. As part of the acquisitions, Peco Foods entered into written

agreements with the seller allocating the purchase price among the acquired assets. Peco

Foods then hired an outside consulting firm to perform a cost segregation study on the

plants and filed a Form 3115 with its return to change its accounting method and reclassify

certain property from nonresidential real property to tangible property. Id. at *3. The IRS

disputed these changes, arguing that the taxpayer could not modify the purchase price

allocations and subdivide them into component assets in a manner at odds with those

schedules. The Tax Court held that Peco Foods was bound by the clear and unambiguous

terms of the original allocation schedules and could not deviate from its characterization of

those assets. Id. at *12. Thus, the taxpayer was not allowed to change its method of

accounting for the acquired assets pursuant to its cost segregation study. It is unclear

whether the holding in Peco Foods would apply to acquisitions other than applicable asset

acquisitions under § 1060.

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5. Tangible Regulations – Treas. Reg. §§§ 1.263(a)-1, -2, -3

The final tangible property regulations (“final regulations”), published on September 19,

2013, are generally effective for taxable years beginning on or after January 1, 2014.

Taxpayers have used cost segregation studies to determine what constitutes § 1245

(personal) or § 1250 (real) property for many years. Historically, these cost segregation

studies have resulted in advantageous depreciation deductions for taxpayers. With the

issuance of the final tangible property regulations, the demand for cost segregation studies

is on the rise.

In many cases, taxpayers who previously decided not to conduct cost segregation studies

for depreciation purposes are hiring specialists with engineering expertise to determine

units of property for purposes of applying the improvement rules. Even taxpayers that

conducted these studies in the past are once again hiring specialty firms or CPAs to take

another look at their units of property and associated costs.

Cost segregation studies now serve additional purposes. For example, not only do these

studies reclassify a building’s components into assets with shorter class lives, but they also

identify building systems for purposes of applying the improvement rules. These studies are

also used to identify functionally interdependent plant property and to determine individual

components or groups of components that perform a discrete and critical function. Such

items may represent a change in accounting method in which the taxpayer must file a Form

3115 to request consent for the change.

The Examiner should request and review all cost segregation (or similar) studies, past and

present and may need to engage the services of an IRS Engineer to determine whether the

study was conducted properly.

The Examiner should also consider if the taxpayer’s adjustments due to a cost segregation

study represent a change in accounting method and if the changes were implemented

properly following the appropriate revenue procedures. See Rev. Proc. 2015-13 (or

successor) and Rev. Proc. 2022-14 (or successor) for current guidance. See the

Capitalization of Tangible Property Audit Technique Guide for additional guidance on

Treas. Reg. §§ 1.263(a)-1 to -3.

6. Revenue Procedures Involving Method Changes

To file a Form 3115 with the Service, a taxpayer needs to follow the procedures outlined in

the applicable revenue procedure. Although taxpayers generally argue that they are simply

reclassifying property placed in service in prior years to “correct” class lives, this

reclassification results in a change in recovery period, depreciation method and/or

convention.

Taxpayers who have adopted an impermissible method of accounting for depreciation (or

amortization) and have either (1) claimed no depreciation, or (2) claimed less than or more

than the allowable amount of depreciation and are making a change described in Treas.

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Reg. § 1.446-1(e)(2)(ii)(d), are generally required to file a Form 3115 under either the

automatic change or non-automatic change procedures (i.e., the voluntary method change

procedures) to change the method of accounting. A taxpayer cannot change an adopted

accounting method by filing an amended return unless specific guidance allows for an

exemption.

The general voluntary method change procedures are found in Rev. Proc. 2015-13 (or

successor) with the list of automatic changes found in Rev. Proc. 2022-14 (or successor).

As provided in Rev. Proc. 2015-13, Section 6, for an automatic change, the original Form

3115 must be attached to the taxpayer’s timely filed (including extension) original federal

income tax return implementing the change in method of accounting for the year of change.

Also, a duplicate copy of the Form 3115 must be filed with the IRS office in Ogden, UT no

earlier than the first day of the year of change and no later than the date the taxpayer files

the original Form 3115 with the federal income tax return for the year of change. If the

automatic change procedures of Rev. Proc. 2015-13 (or successor) do not apply to a

taxpayer’s situation, the non-automatic change procedures should be followed.

The following is a list of the more common compliance issues involving accounting method

changes:

a. Compliance issues for non-automatic method changes:

o Was the ruling letter granting consent to the change followed?

o Is the method the taxpayer implemented consistent with the facts presented and

the representations made in the consent agreement?

o Is the § 481(a) adjustment correct?

o Exam may perfect the method change as an examination adjustment when

deemed appropriate.

o A TAM is required to revoke or modify the ruling letter.

b. Compliance issues for automatic method changes:

o Did the taxpayer fully comply with the provisions in the voluntary method change

procedure (Rev. Proc. 2015-13 or successor)?

o Is the method the taxpayer implemented consistent with the automatic method

change provisions described in Rev. Proc. 2022-14 (or successor) for the

designated change number?

o Is the § 481(a) adjustment correct?

o Exam may perfect the method change as an examination adjustment when

deemed appropriate.

o A TAM is necessary if the taxpayer made the method change in compliance with

the applicable procedures, but the examiner wants to revoke or modify the

method change.

If after reviewing the taxpayer’s cost segregation study and its implementation, the

Examiner determines (1) the taxpayer is using an accounting method that does not clearly

reflect income or is improper under § 446(b); or (2) the taxpayer changed its method of

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accounting without obtaining the consent of the Commissioner under § 446(e), the

Examiner should use the involuntary method change procedures in Rev. Proc. 2002-18 to

resolve these accounting method issues. See IRM 4.11.6.7.

7. Summary

A change in the recovery period, depreciation method, and/or convention for depreciable

property is a change in accounting method. Once a method of accounting is adopted, a

taxpayer is required to obtain the consent of the Commissioner through the timely filing of a

Form 3115 to change the accounting method. Pursuant to Rev. Proc. 2015-13, a taxpayer

may request automatic or non-automatic consent for the change. Although a Form 3115

may be subject to National Office review, it is generally the responsibility of the examiner to

verify the propriety of the revised method of accounting for depreciation and the accuracy

of the § 481(a) adjustment at the time of the examination. The examiner should evaluate

the need to review the cost segregation study that formed the basis for the depreciation re-

computations and the resultant change in accounting method.

The issue regarding a change in accounting method with respect to the re-computation of

depreciation (e.g., those based on cost segregation studies) can be quite complex.

Examiners should consult Treas. Reg. § 1.446-1(e) for further guidance. Examiners should

also contact the Methods of Accounting and Timing Practice Network for assistance

regarding ongoing developments in this area, as well as determining the taxpayer’s

compliance with the proper procedures for changing the accounting method and computing

the adjustment pursuant to § 481(a).

C. Depreciation Overview

1. Introduction

To compute depreciation for assets subject to a cost segregation study, one must use the

proper property classification. The property classes control the applicable recovery period

for assets, which are determined by statute or by reference to class lives. To determine the

proper class lives, assets must be categorized into their appropriate asset classes. Cost

segregation studies generally produce listings or groups of assets, based on asset classes

under the Modified Accelerated Cost Recovery System (MACRS). This chapter provides a

summary of the applicable authorities and available guidelines for classifying property into

their appropriate classes as well as guidelines for computing depreciation deductions by

using the proper depreciation method, recovery period, and convention.

2. MACRS

Internal Revenue Code § 167(a) provides a depreciation allowance for the exhaustion,

wear and tear of property used in a trade or business or held for the production of income.

The depreciation deduction provided by § 167(a) for tangible property placed in service

after 1986 generally is determined under § 168, the Modified Accelerated Cost Recovery

System. MACRS prescribes two methods for determining depreciation allowances: (1) the

general depreciation system in § 168(a) (“GDS”); and (2) the alternative depreciation

67 | Page

system in § 168(g) (“ADS”). A taxpayer generally must use GDS unless the taxpayer is

specifically required to use ADS or the taxpayer elects to use ADS. Under either

depreciation system, the depreciation deduction is computed by using a prescribed

depreciation method, recovery period and convention.

3. Depreciation Periods and Conventions

GDS contains ten property classes, based on the recovery period of an asset (3, 5, 7, 10,

15, 20, 25, 27.5, 39, or 50 years). Applicable depreciation methods include the 200%

declining balance method, 150% declining balance method, and straight-line method. The

depreciation methods under GDS are generally not elective, but a taxpayer may make an

irrevocable election to use a less accelerated method under certain circumstances.

However, 27.5-year property (residential rental property), 39-year property (nonresidential

real property and qualified improvement property), 50-year property (railroad grading or

tunnel bore), and certain 15-year property (i.e., qualified leasehold improvement property,

qualified restaurant property, and qualified retail improvement property placed in service

before January 1, 2018 ) must be depreciated using straight-line depreciation. Note –

qualified improvement property placed in service before January 1, 2018, that also

meets the definition of qualified leasehold improvement property, qualified

restaurant property, or qualified retail improvement property is depreciable over 15-

year straight line as well.

ADS must be used for the following property: 1) listed property used 50 percent or less for

business; 2) tangible property used predominantly outside the United States; 3) tax-exempt

use property; 4) tax-exempt bond financed property; and 5) certain other finite categories of

property that are not common. In addition, a taxpayer may make an irrevocable election to

use ADS for any class of property eligible for depreciation under GDS and placed in service

for a particular tax year. The recovery periods under ADS are generally longer than the

recovery periods under GDS, and the straight-line method must be used.

For purposes of either GDS or ADS, there are three possible conventions: Half-year, mid-

month, and mid-quarter conventions.

a. The half-year convention applies to property other than residential rental property,

nonresidential real property, and railroad grading and tunnel bores. Under this

convention, the recovery period begins or ends on the midpoint of the tax year that

the property is placed in service or disposed of.

b. The mid-month convention applies to residential rental property, nonresidential real

property, and railroad grading and tunnel bores. Under this convention, the recovery

period begins on the midpoint of the month that the property is placed in service.

c. The mid-quarter convention applies to property (other than residential rental property,

nonresidential real property, and railroad grading and tunnel bores) if more than 40%

of the aggregate bases of such property is placed in service during the last three

months of the tax year. Under this convention, the recovery periods for all property

placed in service, or disposed of, during any quarter of a tax year begin on the

midpoint of the quarter.

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Note: Under all conventions, there is no depreciation deduction allowed for property placed

in service and disposed of in the same tax year.

4. Recovery Periods

For purposes of either GDS or ADS, the applicable recovery period is determined by

statute or by reference to class life.

The recovery period of residential rental property, nonresidential real property, and railroad

grading and tunnel bore, are established by statute. See §§ 168(c) and 168(g)(2)(c).

• Residential rental property has a recovery period of 27.5 years for purposes of GDS

and 40 years for purposes of ADS (30 years for purposes of ADS for residential

rental property placed in service after December 31, 2017).

o § 168(e)(2)(A) defines "residential rental property" as any building or structure if

80 percent or more of the gross rental income is rental income from dwelling

units.

• Nonresidential real property has a recovery period of 39 years (or 31.5 years if the

property was placed in service before May 13, 1993) for purposes of GDS and 40

years for purposes of ADS.

o § 168(e)(2)(B) defines "nonresidential real property" as § 1250 property which is

not residential rental property or property with a class life of less than 27.5 years.

• Railroad grading and tunnel bore have a recovery period of 50 years for purposes of

both GDS and ADS. §§ 168(c) and 168(g)(2)(c).

• 15-Year Real Property: Under MACRS, while real property generally has a recovery

period of 39 years (nonresidential real property or 27.5 years (residential rental

property), the following designated real property is 15-year property:

o Qualified leasehold improvement property (QLIP), defined in IRC former §

168(e)(6) circa 2005, placed in service between 10/22/2004 and

12/31/17.Qualified restaurant property (QRP), defined in IRC former § 168(e)(7)

circa 2005, placed in service between 10/22/2004 and 12/31/17. Qualified retail

improvement property (QRIP), defined in IRC former § 168(e)(8) circa 2009,

placed in service between 12/31/2008 and 12/31/17.

o These properties have a recovery period of 15 years and must be depreciated by

the straight-line method and half-year convention (unless the mid-quarter

convention applies). Under the alternative depreciation system (ADS) these

properties have a recovery period of 39 years. See Chapter 6.H for the IRC §

179 and bonus depreciation treatment of QLIP, QRP, and QRIP.

• Qualified Improvement Property was created in 2015 to make certain § 1250

improvement property, placed in service after 1/1/16, eligible for bonus depreciation

(§ 168(k)). It is defined as any improvement to an interior portion of a building if the

improvement is placed in service after the date the building was first placed in

service. However, QIP does not include any improvement attributable to the

enlargement of the building, any elevator or escalator, or the internal structural

framework of the building. QIP was defined in § 168(k)(3) for property placed in

service prior to 1/1/18. For property placed in service on or after that date it is

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defined in § 168(e)(6). QIP typically has a recovery period of 39 years for (GDS)

and 40 years for ADS. However, QIP placed in service after 12/31/2015 and before

1/1/2018 has a 15-year recovery period for GDS if it also meets the definition of

QLIP, QRP, or QRIP. In 2020, the CARES Act (P.L. 116-136) retroactively changed

the recovery period for QIP placed in service after 12/31/2017 from 39 years to 15

years (GDS) and from 40 years to 20 years (ADS) with the addition of IRC §

168(e)(3)(E)(vii). The definition of QIP in IRC § 168(e)(6)(A) was also clarified to

include only those improvements "made by the taxpayer" to an interior of the

building…"

Recovery Period for Qualified Real Property

Place

In Service

Range

Qualified Leasehold

Improvement

Property

(QLIP)

Qualified

Restaurant

Property **

(QRP)

Qualified Retail

Improvement

Property

(QRIP)

Qualified

Improvement

Property

(QIP)

10/22/2004 -

12/31/2008

15SL (GDS)

39 (ADS)

15SL (GDS)

39 (ADS)

1/1/2009 –

12/31/2015

15SL (GDS)

39 (ADS)

15SL (GDS)

39 (ADS)

15SL (GDS)

39 (ADS)

1/1/2016 –

12/31/17

15SL (GDS)

39 (ADS)

15SL (GDS)

39 (ADS)

15SL (GDS)

39 (ADS)

39 GDS – 40

ADS *

2018 and beyond

15SL GDS – 20

ADS ***

* If QIP also meets the definition of QLIP, QRP, or QRIP it is depreciable over 15 - Year SL (GDS)

and 39-Yr SL (ADS).

** Initially, QLIP, QRP, and QRIP applied only to new improvements to the interior of the building. After

2008 QRP applies to the entire building for both new and purchased property and the 3-year rule was

eliminated.

*** For property placed in service after 12/31/17, QIP replaces QLIP, QRP, and QRIP. QIP was

retroactively given a GDS 15-year recovery period and ADS 20-year recovery period pursuant to the

CARES Act.

Section § 168(i)(12) provides that the terms “§ 1245 property” and “§ 1250 property” have

the meanings given such terms by § 1245(a)(3) and § 1250(c), respectively.

Section § 1245(a)(3) provides that "§ 1245 property" is any property which is or has been

subject to depreciation under § 167 and which is either personal property or other tangible

property (not including a building or its structural components) that was used as an integral

part of certain activities

Section § 1250(c) defines "§ 1250 property" as any real property, other than § 1245

property, which is or has been subject to an allowance for depreciation. In other words, §

1250 property encompasses all depreciable property that is not § 1245 property.

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Section § 1245(a)(3) provides that "§ 1245 property" is any property which is or has been

subject to depreciation under § 167 and which is either personal property or other tangible

property (not including a building or its structural components) that was used as an integral

part of certain activities. Such activities include manufacturing, production, or extraction,

furnishing transportation, communication, electrical energy, gas, water, or sewage disposal

services. Certain other "special use" property also qualifies as § 1245 property, but is not

relevant to this discussion. It is important to note that a building or its structural components

is specifically excluded from the definition of § 1245 property.

Treasury Regulation (Treas. Reg.) § 1.1245-3 defines "tangible personal property," "other

tangible property," "building," and "structural component" by reference to Treas. Reg.

§ 1.48-1. This regulation relates to former § 48, which was enacted in 1962 along with

§§ 1245 and 1250. Section 48 allowed an investment tax credit (ITC) based on the

"applicable percentage" of the investment in tangible depreciable property placed in service

during the taxable year. The ITC (§ 48) was later repealed in 1986. See the previous

chapter, Legal_Framework, for a description of the provisions set forth in Treas. Reg. §

1.48-1.

5. Class Lives

Section § 168(i)(1) provides that the term "class life" means the class life (if any) that would

be applicable with respect to any property as of January 1, 1986, under former § 167(m) as

if it were in effect and the taxpayer were an elector. Prior to its revocation, former § 167(m)

provided that in the case of a taxpayer who elected the asset depreciation range system of

depreciation, the depreciation deduction would be computed based on the class life

prescribed by the Secretary which reasonably reflects the anticipated useful life, and the

anticipated decline in value over time, of the property to the industry or other group.

Treas. Reg. § 1.167(a)-11(b)(4)(iii)(b) sets out the method for asset classification under

former § 167(m). Property is included in the asset guideline class for the activity in which

the property is primarily used, regardless of whether the activity is insubstantial in relation

to all the taxpayer's activities. Thus, for depreciation purposes, a taxpayer may be engaged

in more than one activity. If a taxpayer uses assets in more than one activity, the cost of the

asset is not allocated between the two activities; rather, the total cost of the asset will be

classified for depreciation purposes according to the activity in which the asset is primarily

used. This determination may be made in any reasonable manner. Note that in Revenue

Procedure (Rev. Proc.) 97-10, 1997-1 C.B. 628, either a gross receipts test or a square

footage test was used to determine whether a building was primarily used as a retail motor

fuels outlet.

For example, assume that a taxpayer owns and operates a hotel/casino complex. The

taxpayer is engaged in two business activities: casino operations and hotel operations.

Assets used by the taxpayer in its casino operations are includible in the activity category

that includes casino operations (asset class 79.0 Recreation of Rev. Proc. 87-56). Assets

used in hotel operations are includible in the activity category that includes hotel operations

(asset class 57.0 Distributive Trades and Services of Rev. Proc. 87-56). If a particular asset

is used in both activities, the total cost of the asset will be classified for depreciation

71 | Page

purposes according to the activity in which the asset is primarily used; the cost of the asset

is not allocated between the two activities. The determination of primary use may be made

in any reasonable manner. For additional information, see IRS FSA 200203009.

Asset classifications are based on how the asset is primarily used. In the case of a lessor of

property, the asset class for such property is determined as if the property were owned by

the lessee. See Treas. Reg. § 1.167(a)-11(e)(3)(iii) and the following court cases for

additional information and consideration.

• Clajon Gas Co. L.P. v. Commissioner, 354 F.3d 786 (8th Cir. 2004), rev’g 119 T.C.

197 (2002): Pipelines leased to producers to transport natural gas fell under the

asset class for producing natural gas regardless of ownership.

• Saginaw Bay Pipeline Co. v. United States, 338 F.3d 600 (6th Cir.2003), rev’g 124

F.Supp.2d 465 (E.D. Mich. 2001): Every natural gas carriage pipeline which functions

as a gathering pipeline is in the methane gas production process irrespective of the

primary business of the owner of that pipeline.

• Duke Energy Natural Gas Corp. v. Commissioner, 172 F.3d 1255 (10th Cir.1999),

rev’g 109 T.C. 416 (1997): Based on the asset's primary use, the classification of

natural gas gathering systems constituted as assets used in the production of natural

gas.

As stated earlier, GDS contains ten property classes, based on the recovery period of an

asset. For those classes of property not established by statute, the applicable recovery

period is determined by reference to class life. See § 168(e)(1). It is also worth noting that

qualified Indian reservation property, generally have shorter applicable recovery periods.

See § 168(j)(1) and (2).

6. Revenue Procedure 87-56

Revenue Procedure 87-56, 1987-2 C.B. 674, sets forth the class lives of property that are

necessary to compute the depreciation allowances under § 168 (MACRS). The revenue

procedure establishes two broad categories of depreciable assets:

1. Asset classes 00.11 through 00.4 that consist of specific assets used in all business

activities.

2. Asset classes 01.1 through 80.0 that consist of assets used in specific business

activities.

The same item of depreciable property can be described in both an asset category (asset

classes 00.11 through 00.4) and an activity category (asset classes 01.1 through 80.0). In

this situation, the item is classified to the asset category unless it is specifically excluded

from the asset category or specifically included in the activity category. For additional

guidance see below:

• Norwest Corporation & Subsidiaries v. Commissioner, 111 T.C. 105 (1998) (item

described in both an asset and an activity category (furniture and fixtures) should be

placed in the asset category)

72 | Page

• Rev. Rul. 2003-81, 2003-2 C.B. 126 (an asset included in both an asset category and

an activity category is placed in the asset category, unless it is specifically excluded

from the asset category or specifically included in the activity category).

Revenue Procedure 87-56 contains tables of class lives and recovery periods. To properly

utilize Rev. Proc. 87-56, the following steps are suggested:

1. Check Asset Classes 00.11 through 00.4 that consist of specific assets used in all

business activities to see if it contains a description of the asset in question.

o Refer below to Step 2 (if the asset is described in an asset category) or to Step 3

(if the asset is not listed in an asset category).

2. If the subject asset is described in one of the asset categories, then check asset

classes 01.1 through 80.0 that consist of assets used in specific business activities to

find the activity to which the property relates or in which it is primarily being used.

o If the activity is described in one of the activity categories, read the text (if any)

under the title to determine if the property is specifically included in the activity

category.

o If it is, then use the recovery period shown for the activity category following the

description of that activity.

o If the property is not specifically included in the activity category, or if the property

is specifically excluded from the activity category, then use the recovery period

shown in the appropriate asset category.

3. If the asset is not listed in an asset category, then find the activity to which the

property relates or in which the property is primarily being used, and use the recovery

period shown in the appropriate column following the activity category description.

o If the property is not listed in an asset category and the activity to which it relates

is not included in one of the activity categories, then the property should be

categorized as "Certain Property for which Recovery Periods assigned (Personal

Property/§ 1245 Real Property with No Class Life)." Property in this category

generally has a recovery period of 7 years for GDS or 12 years for ADS. Please

note that there are very few assets that fall under this default category.

7. Examples

The following examples illustrate the use of Rev. Proc. 87-56 for determining the proper

asset recovery period. See also Appendix B of IRS Publication 946.

Example 1: Richard Green is a paper manufacturer. During the year, he made substantial

improvements to the land on which his paper plant is located. Assume that these land

improvements are depreciable property. He checks the asset categories and finds land

improvements under Asset Class 00.3 Land Improvements. He then checks the activity

categories and finds his activity, paper manufacturing, under Asset Class 26.1,

Manufacture of Pulp and Paper.

If Richard had only looked at the asset categories, he would have erroneously selected

Asset Class 00.3, Land Improvements, and would have incorrectly used a recovery period

73 | Page

of 15 years for GDS or 20 years for ADS. However, Richard uses the recovery period under

Asset Class 26.1 Manufacture of Pulp and Paper, because it specifically includes land

improvements. Thus, the land improvements have a 13-year class life and a 7-year

recovery period for GDS. If he elects to use ADS, the recovery period is 13 years.

[Note: It is presumed in this example that the subject land improvements are directly

associated with the factory site or production process, for example, effluent ponds or canals

necessitated by the production process, or parking lots utilized by employees directly

involved with the production process. However, those land improvements that are more

closely associated with non-production activities, such as administrative or retail activities

of the taxpayer, would be categorized in Asset Class 00.3 Land Improvements and have a

15-year recovery period under GDS. See Rev. Rul. 2003-81, 2003-2 C.B. 126.]

Example 2: Sam Plower produces rubber products. During the year, he made substantial

improvements to the land on which his rubber plants are located. Assume that these land

improvements are depreciable property. He checks the asset categories and finds land

improvements under Asset Class 00.3. He then checks the activity categories and finds his

activity, producing rubber products, under Asset Class 30.1, Manufacture of Rubber

Products. Reading the headlines and descriptions under Asset Class 30.1, Sam finds that it

does not specifically include land improvements. Therefore, Sam uses the recovery period

for Asset Class 00.3 Land Improvements. Thus, the land improvements have a 20-year

class life and a 15-year recovery period for GDS. If he elects to use ADS, the recovery

period is 20 years.

Example 3: Pam Martin owns a retail-clothing store. During the year, she purchased a desk

and a cash register for use in her business. She checks the asset categories and finds

office furniture under Asset Class 00.11 Office Furniture, Fixtures, and Equipment. Cash

registers are not specifically listed in any of the asset categories. She then checks the

activity categories and finds her activity, retail store, under Asset Class 57.0 Distributive

Trades and Services, which includes assets used in wholesale and retail trade. The

description for this asset class does not specifically list office furniture or a cash register.

She looks back at the asset categories and uses Asset Class 00.11 for the desk, since it

constitutes office furniture. Thus, the desk has a 10-year class life and a 7- year recovery

period for GDS. If she elects to use ADS, the recovery period is 10 years. For the cash

registers are not specifically listed in one of the asset categories but are assets used in

retail business. Accordingly, the cash register has a 9-year class life and a 5-year recovery

period for GDS. If she elects to use the ADS method, the recovery period is 9 years.

8. Additional References for Determining the Proper Activity Category for

Property

The Standard Industrial Classification Manual (SIC) published by the Office of Management

and Budget can provide insight into the content of the asset classes described in Rev.

Proc. 87-56. Care must be exercised because SIC does not make use of the same

74 | Page

classification techniques and depreciation concepts of Rev. Proc. 87-56. While SIC has

precise categorization by primary business activity using language very similar to that found

in Rev. Proc. 87-56, the revenue procedure departs dramatically from the categorization

scheme of SIC by establishing two broad categories of depreciable assets: (1) asset

classes 00.11 through 00.4 that consist of specific assets used in all business activities;

and (2) asset classes 01.1 through 80.0 that consist of assets used in specific business

activities. However, the asset class numbers for the specific business activities described in

Rev. Proc. 87-56 are largely taken from SIC.

Additionally, it may be helpful to look at the North American Industry Classification System

(NAICS). NAICS was introduced in 1997 to replace the SIC system and more closely

reflects the many new industries that have propagated since the establishment of the SIC

system in 1937, including many service industries currently under-represented in the SIC

system. Although the manner of categorization is similar under both SIC and NAICS, the

category codes are vastly different, which is why the Service generally does not look to

NAICS for insight purposes. However, NAICS can be helpful (because of its expanded

description of service industries) in determining in which one of two activity categories, a

particular asset should be categorized.

D. Relevant Court Cases

1. Introduction

In addition to the legal framework presented earlier in Chapter 2, the court cases listed

below provide further guidance as to whether a particular asset constitutes § 1245 property

or § 1250 property. Although the issue in many of the cases below relates to whether

property is eligible for the now-expired investment tax credit (ITC), the precedent that was

developed to ascertain whether property constituted eligible property for purposes of ITC is

equally applicable to ascertain whether property constitutes as § 1245 property for

purposes of ACRS/MACRS.

Unfortunately, there are no bright-line tests for distinguishing § 1245 property from § 1250

property. Each of the cases below is factually intensive. Additionally, opinions by different

courts sometimes conflict; therefore, an ultimate determination of the categorization of an

asset generally cannot be based upon reading merely one case. In addition to reading all of

the cases on point, one must also consider whether the Service has acquiesced to a

particular position or case. Advice should be sought where the asset at issue is not

specifically discussed in any of the below opinions, if one is not sure of how to categorize a

specific asset, or if the opinions are vague or conflicting.

2. Arrangement of Information

This chapter contains two tables to assist examiners in locating pertinent cases that

address specific assets:

Table 1: Case Law by Case Name (in reverse chronological order)

75 | Page

Table 2: Case Law listed by CSI MasterFormat Division (both 2004 (50 divisions) and 1995

(16 divisions))

NOTE: Cost Segregation studies are often organized following the Construction

Specifications Institute (CSI) MasterFormat Division system. The CSI MasterFormat system

is a master list of numbers and titles classified by construction trades (concrete, electrical,

plumbing, mechanical, carpentry, masonry, steel, etc.) that was developed to simplify and

facilitate communication within the construction industry. The inclusion of the CSI

MasterFormat Divisions in these tables is for informational purposes only and is not an

endorsement of either the Construction Specifications Institute or the MasterFormat

system.

For reference purposes, this chapter also contains a third table listing all the CSI

MasterFormat Divisions for both the 2004 and 1995 editions:

Table 3: Listing of CSI MasterFormat Divisions (both 2004 (50 divisions) and 1995 (16

divisions))

3. Table 1: Case Law by Case Name (Reverse Chronological Order)

Date Case Name/Citation

Asset Comments

3/12/2012 AmeriSouth XXXII, Ltd.

v. Commissioner, T.C.

Memo. 2012-67

Site prep and earthwork

(nondep.)

Water distribution system

(§1250)

Sanitary sewer system (§1250)

Gas line (§1250)

Site electric (§1250)

Special HVAC – dryer vents

(§1245)

Special HVAC – kitchen vent

hoods (§1250)

Special plumbing – sinks and

garbage disposals (§1250)

Special plumbing – laundry

drain and waste lines (§1250)

Special plumbing – dryer gas

lines (§1245)

Special electric (§1245/§1250)

Finish carpentry (§1250)

Millwork (§1250)

Interior windows & mirrors

(§1250)

Special painting (§1250)

Enumerates three

categories of §1245

property: 1) accessory to

a business; 2) non-

permanence; and 3) is

ornamental or decorative.

76 | Page

Date Case Name/Citation

Asset Comments

7/28/2010

PPL Corporation &

Subs. v. Commissioner,

135 T.C. 176 (2010)

Street Lights

Street light assets did not

fall with asset class 49.14

Utility Transmission and

Distribution Plant, nor

within asset class 00.3

Land Improvements.

They fall within the

residual asset class to

which a 7-year recovery

period.

4/3/2007 Trentadue v.

Commissioner, 128

T.C. 91 (2007)

Well (§1250 land improvement)

Underground irrigation system

(§1250 land improvement)

Trellises (§1245)

5/28/1998 L.L. Bean, Inc. v.

Commissioner, 145

F.3d 53 (1st Cir. 1998),

aff’g T.C. Memo. 1997-

175

Storage rack system (also

supports roof and walls)

(§1250)

Concrete slab floor (§1250)

Roof and wall panels (§1250)

Electrical system (§1250)

Heating/ventilation sys. (§1250)

Fire protection system (§1250)

Mezzanine system (§1250)

12/10/1997 SuperValu Inc. v.

United States, 993

F.Supp. 1243 (D.Minn.

1997)

Refrigeration system (§1245)

7/24/1997 Hospital Corp. of

America & Subs. v.

Commissioner, 109

T.C. 21 (1997)

Primary and secondary

electrical distribution sys.

(§1245/§1250)

Special electrical equip. and

branch wiring (§1245)

TV equipment and wiring

(§1245)

Telephone equip., wiring, jacks,

and intercom equip. (§1245)

Carpeting (§1245)

Vinyl wall covering (§1245)

Vinyl floor covering (§1245)

Kitchen water piping, grease

trap system, and steam lines,

(§1245)

Landmark case setting

precedent that criteria

developed to ascertain

whether property

constituted eligible

property for purposes of

ITC is equally applicable

to ascertain whether

property constitutes §

1245 property for

purposes of

ACRS/MACRS. In AOD

1999-008, the IRS

acquiesced in part

regarding definition of

tangible personal

property and non-

acquiesced in part

77 | Page

Date Case Name/Citation

Asset Comments

Kitchen hoods and exhaust

system (§1245)

Patient corridor handrails

(§1245)

Over-bed fluorescent lights

(§1250)

Partitions/room dividers

(§1245)

Bathroom accessories (§1250)

Acoustical ceilings (§1250)

Steam boilers (§1250)

regarding determination

of individual assets in

dispute.

6/6/1997 Schrum v.

Commissioner, 114

F.3d 1177 (4th Cir.

1997), aff’g in part and

vac’g in part without

published opinion, T.C.

Memo. 1995-103, on

remand from 33 F.3d

426 (4th Cir. 1994),

aff’g in part and vac’g in

part, T.C. Memo. 1993-

124

Car wash facility structure

(§1250)

Plumbing system (§1245)

Electrical system (§1245)

This is a Fourth Circuit

case that follows the

precedent in A.C. Monk

and does not represent

the predominant view of

the issue.

11/4/1996 Boddie-Noelle

Enterprises. Inc. v.

United States, 36

Fed.Cl. 722 (1996),

aff’d without published

opinion, 132 F.3d 54

(Fed.Cir. 1997)

Suspended ceilings (§1250)

Roof panels - mansard (§1250)

Electrical connected to

equipment (§1250)

Plumbing connected to

equipment (§1250)

Kitchen HVAC (§1250)

Decorative mirror (§1250)

Drive-thru window units (§1250)

The court determined that

any items expressly listed

as a building or structural

component in the

regulations are excluded

from being tangible

personal property. This

approach is precedent

only for the Federal

Claims Court and has not

been followed by other

courts.

8/13/1996 Walgreen Co. & Subs.

v. Commissioner, T.C.

Memo. 1996-374, on

remand from 68 F.3d

1006 (7th Cir. 1995),

rev’g 103 T.C. 582

(1994)

Partitions (drywall, glass)

(§1250)

Restroom partition (metal)

(§1250)

Doors, framing, millwork,

metalwork, trimwork (§1250)

Ceiling (drywall, acoustic)

(§1250)

78 | Page

Date Case Name/Citation

Asset Comments

Lighting fixtures and wiring (not

emergency/exit lighting)

(§1250)

Floor coverings (carpet, vinyl,

or tile) (§1250)

Decorative finishes, canopies,

signs, concrete piers (§1245)

3/7/1995 La Petite Academy v.

United States, 95-1

USTC ¶ 50,193

(W.D.Mo. 1995), aff’d

without published

opinion, 72 F.3d 133

(8th Cir. 1995)

Wall panels - magnetic (§1250)

Roof - mansard (§1250)

Fencing - playground (§1250)

Exterior façade lighting (§1250)

Fire protection system (§1250)

Heat and smoke detectors

(§1250)

Emergency/exit lights (§1250)

Restroom accessories (§1250)

Kitchen grease trap (§1250)

Kitchen electrical service

(§1250)

Dumpster enclosure (fence and

concrete pad) (§1250)

Thermal recovery system

(§1250)

Doors – split (bypass) (§1250)

12/30/1993 Albertson’s, Inc. v.

Commissioner, 38 F.3d

1046 (9th Cir. 1993),

rev’g T.C. Memo. 1988-

582, cert. denied 516

U.S. 807 (1995)

HVAC system (§1250)

2/25/1993 Grinalds v.

Commissioner, T.C.

Memo. 1993-66

Air conditioning units (§1250)

Partitions (§1250)

Walls (interior) (§1250)

Plumbing – restroom (§1250)

Elec. conduit – restroom

(§1250)

5/27/1992 Texas Instruments Inc.

v. Commissioner, T.C.

Memo. 1992-306

Waste treatment facilities

(§1245)

Drywall partitions (§1250)

Elec. switch gear structure

(§1245)

Water pump structure (§1250)

79 | Page

Date Case Name/Citation

Asset Comments

Water and fuel oil tanks

(§1250)

Lab and special rooms (§1250)

Concrete floor & columns

(§1245)

Concrete slab floor and wood

deck (§1250)

Window wall partitions (§1250)

Ceilings - suspended (§1250)

A/C in telephone room (§1245)

Plumbing for equipment

(§1245)

Emergency doors (§1250)

Localized fire protection sy

stem

(§1245)

Sprinkler heads (§1250)

Security fencing (§1245)

Interior landscaping (§1245)

Exterior landscaping (§1250)

Electrical – substations and

transformers (Cat. 1) (§1250)

Electrical –

high voltage system

(Cat. 2) (§1250)

Electrical – spare transformers,

breakers, cable (Cat. 3)

(§1250)

Electrical – systems dedicated

to equipment (Cat. 4) (§1245)

4/28/1992 Publix Supermarkets,

Inc. v. United States, 26

Cl.Ct. 161 (1992)

HVAC system (§1250)

5/14/1991

Wood v. Commissioner,

T.C. Memo. 1991-205

Solar water-heating equip.

(§1245)

1/9/1990

Morrison, Inc. v.

Commissioner, 891

F.2d 857 (11th Cir.

1990), aff’g T.C. Memo.

1986-129

Emergency lighting (§1245)

Kitchen elec. panel boards

(§1245)

Kitchen hand sinks (§1250)

Kitchen water piping (§1245)

Eliason doors (§1245)

Restroom accessories (§1250)

Decor window treatment

(§1245)

In AOD 1991-19, the IRS

acquiesced to the

functional allocation

approach based, in part,

on the Morrison case.

80 | Page

Date Case Name/Citation

Asset Comments

Lattice millwork (§1245)

Vanity cabinets/counters

(§1250)

Customer line screen (§1245)

Serving line concrete curb

(§1250)

Kitchen heat recovery unit

(§1245)

Floors - insulated (cooler,

freezer, garbage room) (§1250)

Garbage room (§1250)

Kitchen walls & floor tiles

(§1250)

Kitchen air makeup unit

(§1245)

Kitchen drainage system

(grease trap) (§1245)

Electric water coolers (§1250)

Chandeliers and dimmers

(§1245)

Kitchen hot water heater

(§1245)

Primary electric distribution

system (§1245/§1250)

11/22/1988

McManus v. United

States, 863 F.2d 491

(7th Cir. 1988), aff’g

700 F. Supp. 994

(W.D.Wis. 1987)

Airplane hangar (§1250)

Hangar doors & partitions

(§1250)

7/21/1988 Munford, Inc. v.

Commissioner, 849

F.2d 1398 (11th Cir.

1988), aff’g 87 T.C. 463

(1986)

Truck loading platform (§1250)

Rail loading platform (§1250)

Refrigerated area (§1245)

9/15/1987 Lukens, Inc. v.

Commissioner, T.C.

Memo. 1987-464

Craneway structures (§1245)

1/20/1987 Metro National Corp. v.

Commissioner, T.C.

Memo. 1987-38

Partitions (gypsum drywall)

(§1245)

Partitions – glass storefront

(§1245/§1250)

Partitions – toilet/restroom

(§1250)

81 | Page

Date Case Name/Citation

Asset Comments

False ceilings with lighting

(§1250)

Exterior security lighting

(§1245)

Interior grow lights (§1245)

Exterior accent lighting (§1245)

Cabinets and hardware (§1245)

Sprinkler heads (§1250)

11/13/1986

Piggly Wiggly Southern,

Inc. v. Commissioner,

803 F.2d 1572 (11th

Cir. 1986), aff’g 84 T.C.

739 (1985)

HVAC units (§1245)

In AOD 1988-22, the IRS

non-acquiesced to the

court not using the sole

justification test for HVAC

systems.

4/28/1986

Illinois Cereal Mills, Inc.

v. Commissioner, 789

F.2d 1234 (7th Cir.

1986), aff’g T.C. Memo.

1983-469, cert. denied,

479 U.S. 995 (1986)

Electrical distribution system

(§1245/§1250) (95%/5%)

In AOD 1988-20, the IRS

non-acquiesced to the

use of the functional

allocation approach for

electrical systems. In

AOD 1991-19, the IRS

acquiesced to the

functional allocation

approach.

11/4/1985

Mallinckrodt, Inc. v.

Commissioner, 778

F.2d 402 (8th Cir.

1985), aff’g T.C. Memo.

1984-532

Partitions (gypsum drywall)

(§1250)

1/24/1985 Duaine v.

Commissioner, T.C.

Memo. 1985-39

Concrete foundation slab

(§1250)

Kitchen wall and floor tiles

(§1250)

Plumbing, gas lines, electrical

conduits to equipment (§1245)

Interior and exterior ornamental

lighting fixtures (§1250)

8/6/1984 Shoney’s South, Inc. v.

Commissioner, T.C.

Memo. 1984-413

Chandeliers and lanterns

(§1245)

In AOD 1986-48 the IRS

non-acquiesced that

certain lighting was

decorative and thus

eligible for the ITC.

6/17/1983 Consolidated

Freightways, Inc. v.

Commissioner, 708

F.2d 1385 (9th Cir.

Truck loading docks (§1250)

Dock overhead doors (§1250)

Dock lighting (§1250)

82 | Page

Date Case Name/Citation

Asset Comments

1983), aff’g in part and

rev’g in part, 74 T.C.

768 (1980)

8/27/1982 A.C. Monk & Co. v.

United States, 686 F.2d

1058 (4th Cir. 1982),

aff’g in part and rev’g in

part, E.D.N.C. No. 78-

126-CIV-4 (August 4,

1981), on remand to

577 F.Supp. 4

(E.D.N.C. 1983)

Louvered wall (§1245)

Truck apron (concrete pad)

(§1245)

Restroom furnishings (§1250)

Railroad concrete platform

(§1250)

Elec. distribution system

(§1250)

Green storage room (§1250)

High bay portion of roof (§1250)

Wiring for computer room

(§1245)

Environmental control rooms

(§1245)

Fire hose wall stations (§1250)

Storage sheds (§1245)

Court used adaptability

test for electrical systems

(not functional allocation

method). Opinion should

be followed only in cases

appealable to the Fourth

Circuit.

5/26/1982 Circle K Corp. v.

Commissioner, T.C.

Memo. 1982-298

A/C units (roof) (§1250)

Cold storage room (§1250)

4/20/1981

Samis v.

Commissioner, 76 T.C.

609 (1981)

Boiler structure (concrete)

(§1250)

Energy plant (§1250)

A/C and heating system

(§1250)

4/28/1980 Scott Paper Co. v.

Commissioner, 74 T.C.

137 (1980)

Primary electric distribution

system (§1245/§1250)

Secondary electric distribution

system (§1245/§1250)

Landmark case setting

forth functional allocation

method for allocating

components of an

electrical distribution

system into §§ 1245/1250

property.

6/18/1979 Dixie Manor, Inc. v.

United States, 79-2

USTC ¶ 9469 (W.D.Ky.

1979), aff’d, in unpub.

opinion, 652 F.2d 57

(6th Cir. 1981)

A/C & heating units (roof)

(§1250)

Partitions (drywall) (§1250)

2/13/1978 Westroads, Inc. v.

Commissioner, 69 T.C.

682 (1978)

Elec. generating equip. (§1245)

In AOD 1979-173, the

IRS acquiesced to the

result.

83 | Page

Date Case Name/Citation

Asset Comments

12/31/1975

Whiteco Industries, Inc.

v. Commissioner, 65

T.C. 664 (1975)

Outdoor signs (billboards)

(§1245)

Landmark case putting

forth factors for

determining whether

property is inherently

permanent. In AOD 1977-

142, the Service

acquiesced to the criteria

set forth for determining

whether property is

inherently permanent.

1/23/1974

Kramertown Co., Inc. v.

Commissioner, 488

F.2d 728 (5

Cir. 1974),

aff’g T.C. Memo. 1972-

239

A/C & heating units (roof)

(§1250)

12/3/1973

Everhart v.

Commissioner, 61 T.C.

328 (1973)

Sewage disposal system

(§1250)

Property is structural

component even though

not directly attached to

the building.

11/6/1973 King Radio Corp., Inc.

v. United States, 486

F.2d 1091 (10th Cir.

1973), aff’g D.Kan., No.

KC-3320 (Oct. 30,

1972)

Partitions: movable sys.

(§1245)

Partitions (ceiling height)

(§1245)

Partitions (5’6” height) (§1245)

Doors (in partitions) (§1245)

In AOD 1972 WL 33204,

the IRS recommended

appeal of the Tax Court

case. In AOD 1975-580,

the IRS acquiesced to the

Circuit Court case.

6/12/1973

Coors v. Commissioner,

60 T.C. 368 (1973)

Duct work (filter system)

(§1250)

Saw room (§1250)

Valve-testing room (§1250)

5/24/1972 Central Citrus Co. v.

Commissioner, 58 T.C.

365 (1972)

Sweet rooms (§1245)

Blowers and coolers (§1245)

Electrical system

(§1245/§1250)

Elec. panel & transformer

(§1250)

Electrical outlets (§1250)

Elec. distribution system:

adapters, fuses, switches,

relays (§1245)

Lights: fluorescent, moisture-

proof (§1245)

Lights: spotlights & flood

(§1245)

In AOD 1972 WL 33052,

the IRS acquiesced to the

decision. Note that there

was a subsequent

change in statute to

replace the term “storage

facility” with the narrower

concept of a “facility used

… for the bulk storage of

fungible commodities.”

84 | Page

Date Case Name/Citation

Asset Comments

Lights: ballast and exterior

(§1245)

12/28/1970

Minot Federal Sav. &

Loan Ass’n v. United

States, 435 F.2d 1368

(8th Cir. 1970), aff’g

313 F. Supp. 294

(D.N.D. 1970)

Partitions: movable sys.

(§1245)

Determination of

structural component

based on permanency

test, not functional use

test.

3/26/1970 Fort Walton Square,

Inc. v. Commissioner,

54 T.C. 653 (1970)

A/C and heating system

(§1250)

10/27/1969

Ponderosa Mouldings

Inc. v. Commissioner,

53 T.C. 92 (1969)

Sprinkler system (§1250)

5/16/1968 Catron v.

Commissioner, 50 T.C.

306 (1968)

Sorting and boxing room

(§1250)

Refrigerated room (§1245)

Landmark case that held

that a building could be

allocated into portions for

purposes of the ITC. In

AOD 1968 WL 16712, the

IRS acquiesced in result

only (not to the court’s

rationale). In AOD 1972

WL 33051, the IRS

acquiesced to the

rationale of the court.

4. Table 2: Case Law by CSI MasterFormat Divisions (2004 and 1995)

CSI Master

Format 2004

Classification

CSI Master

Format 95

Classification

Asset

IRC

§1245

Prop.

IRC

§1250

Prop.

Case Name

Division 03 – Concrete

Division 03 –

Concrete

Division 03 –

Concrete

Division 03 – Concrete

030000 03000 Concrete slab floor X L.L. Bean

030000 03000

Concrete slab floor & wood

deck

Texas

Instruments

030000 03000 Concrete floor & columns X

Texas

Instruments

030000 03000 Waste treatment facilities X

Texas

Instruments

030000 03000 Truck loading platform X Munford

030000 03000 Truck loading dock X

Consol.

Freight.

85 | Page

CSI Master

Format 2004

Classification

CSI Master

Format 95

Classification

Asset

IRC

§1245

Prop.

IRC

§1250

Prop.

Case Name

030000 03000 Truck apron (concrete pad) X A.C. Monk

030000 03000 Railroad concrete platform X A.C. Monk

030000 03000 Rail loading platform X Munford

030000 03000

Floors - insulated (cooler,

freezer, garbage room)

X Morrison

030000

033000

03000

03300

Serving line concrete curb X Morrison

031000 03100 Concrete foundation slab X Duaine

Division 04 – Masonry

Division 04 –

Masonry

Division 04 –

Masonry

Division 04 – Masonry

042000 04200 Car wash facility structure X Schrum

042000 04200 Boiler structure (concrete) X Samis

Division 05 – Metals

Division 05 –

Metals

Division 05 –

Metals

Division 05 – Metals

051000 05100 Craneway structures X Lukens

Div. 06 – Wood, Plastics, &

Comp.

Div. 06 – Wood, Plastics, &

Comp.

Div. 06 – Wood, Plastics,

& Comp.

Div. 06 – Wood,

Plastics, & Comp.

Div. 06 – Wood,

Plastics, & Comp.

Div. 06 – Wood, Plastics, &

Comp.

062000 06200 Finish carpentry X AmeriSouth

064000 06400 Millwork X AmeriSouth

064000 06400

Millwork, metalwork,

trimwork

X Walgreen

064400 06440 Lattice millwork X Morrison

066300 05720 Patient corridor handrails X HCA

Div. 07 – Thermal & Moisture

Prot.

Div. 07 – Thermal & Moisture

Prot.

Div. 07 – Thermal &

Moisture Prot.

Div. 07 – Thermal

& Moisture Prot.

Div. 07 – Thermal

& Moisture Prot.

Div. 07 – Thermal & Moisture

Prot.

074000 13140 Roof and wall panels X L.L. Bean

074000 06170 Roof panels – Mansard X Boddie-Noelle

074000 06170 Roof – Mansard X La Petite Acad.

074000 05100 High bay portion of roof X A.C. Monk

Division 08 – Openings

Division 08 –

Openings

Division 08 –

Openings

Division 08 – Openings

081000 08100 Doors, framing X Walgreen

081000 08100 Emergency Doors X

Texas

Instruments

081000 08000 Doors (in partitions) X King Radio

083000 08300 Doors – split (bypass) X La Petite Acad.

86 | Page

CSI Master

Format 2004

Classification

CSI Master

Format 95

Classification

Asset

IRC

§1245

Prop.

IRC

§1250

Prop.

Case Name

083300 08330 Dock overhead doors X

Consol.

Freight.

083400 08344 Hangar doors X McManus

083800 08380 Eliason doors X Morrison

085000 08500 Interior windows & mirrors X AmeriSouth

085600 08582 Drive-thru window units X Boddie-Noelle

088300 08830 Decorative mirror X Boddie-Noelle

0884426 08970 Window wall partitions X

Texas

Instruments

0884426 08970 Partitions – glass storefront

X X

Metro Nat’l

Corp.

089100 15700 Louvered wall X A.C. Monk

Division 09 – Finishes

Division 09 –

Finishes

Division 09 –

Finishes

Division 09 – Finishes

092000 09250 Wall panels – magnetic X La Petite Acad.

092000 09250 Walls (interior) X Grinalds

092000 09250 Partitions X Grinalds

092000 09250 Partitions (drywall, glass) X Walgreen

092000 09250 Drywall partitions X

Texas

Instruments

092000 09250 Partitions (gypsum drywall) X

Metro Nat’l

Corp.

092000 09250 Partitions (gypsum drywall) X Mallinckrodt

092000 09250 Partitions (drywall) X Dixie Manor

092000 09250 Customer line screen X Morrison

093000 09300 Kitchen walls and floor tiles X Morrison

093000 09300 Kitchen wall and floor tiles X Duaine

095000 09510 Acoustical ceilings X HCA

095000 09500 Ceilings (drywall, acoustic) X Walgreen

095000 09500 Suspended Ceilings X Boddie-Noelle

095000 09500 Ceilings - suspended X

Texas

Instruments

095000 09510 False ceilings with lighting X

Metro Nat’l

Corp.

87 | Page

CSI Master

Format 2004

Classification

CSI Master

Format 95

Classification

Asset

IRC

§1245

Prop.

IRC

§1250

Prop.

Case Name

096000 09680

Floor coverings (carpet,

vinyl, tile)

X Walgreen

096000 09680 Carpeting X HCA

096000 09680 Vinyl Floor Covering X HCA

097000 09720 Vinyl Wall Covering X HCA

099000 09900 Special painting X AmeriSouth

Division 10 – Specialties

Division 10 –

Specialties

Division 10 –

Specialties

Division 10 – Specialties

101400 10426 Outdoor signs (billboards) X Whiteco

102000 10800 Restroom partition (metal) X Walgreen

102000 10800 Partitions – toilet/restroom X

Metro Nat’l

Corp.

102200 05300 Metal partitions X McManus

102200 10650 Partitions / Room dividers X HCA

102200 10630 Partitions: movable system X King Radio

102200 10630 Partitions (ceiling height) X King Radio

102200 10630 Partitions (5’6” height) X King Radio

102200 10630 Partitions: movable system X Minot

102800 10800 Bathroom accessories X HCA

102800 10800 Restroom accessories X Morrison

102800 10800 Restroom furnishings X A.C. Monk

102813 10800 Restroom accessories X La Petite Acad.

105600 13140

Storage rack system (also

supports roof and walls)

X L.L. Bean

107316 10536

Decorative finishes,

canopies, signs, concrete

piers

X Walgreen

Division 11 – Equipment

Division 11 –

Equipment

Division 11 –

Equipment

Division 11 – Equipment

113113 11450

Special HVAC – kitchen

vent hoods

X AmeriSouth

Division 12 – Furnishings

Division 12 –

Furnishings

Division 12 –

Furnishings

Division 12 – Furnishings

122000 16500 Décor window treatment X Morrison

123000 06400 Cabinets and hardware X

Metro Nat’l

Corp.

123500 06400 Vanity cabinets & counters X Morrison

88 | Page

CSI Master

Format 2004

Classification

CSI Master

Format 95

Classification

Asset

IRC

§1245

Prop.

IRC

§1250

Prop.

Case Name

Div. 13 – Special Construction

Div. 13 – Special

Construction

Div. 13 – Special

Construction

Div. 13 – Special

Construction

Div. 13 – Special

Construction

Div. 13 – Special Construction

132000 13030 Garbage room X Morrison

132000 13030 Sorting and boxing room X Catron

132000 13030 Lab and special rooms X

Texas

Instruments

132000 13030 Saw room X Coors

132000 13030 Valve-testing room X Coors

132000 13030 Green storage room X A.C. Monk

132000 13120

Environmental control

rooms

X A.C. Monk

132000 13030 Sweet rooms X Central Citrus

132126 13030 Refrigerator area X Munford

132126 13030 Refrigerated room X Catron

132126 13030 Cold storage room X Circle K

133400 13120 Mezzanine system X L.L. Bean

133400 13120 Water pump structure X

Texas

Instruments

133400 13120 Elec. switch gear structure X

Texas

Instruments

133419 13120 Storage sheds X A.C. Monk

133419 13120 Airplane hangar X McManus

Division 21 – Fire Suppression

Division 21 – Fire

Suppression

Division 21 – Fire

Suppression

Division 21 – Fire

Suppression

Division 21 – Fire

Suppression

Division 21 – Fire Suppression

211100 15300 Fire protection system X L.L. Bean

211100 15300 Fire protection system X La Petite Acad.

211100 15300 Fire hose wall stations X A.C. Monk

211100 15300

Localized fire protection

system

Texas

Instruments

211100 15300 Sprinkler heads X

Texas

Instruments

211100 15300 Sprinkler system X Ponderosa

Division 22 - Plumbing

Division 22 -

Plumbing

Division 22 -

Plumbing

Division 22 - Plumbing

89 | Page

CSI Master

Format 2004

Classification

CSI Master

Format 95

Classification

Asset

IRC

§1245

Prop.

IRC

§1250

Prop.

Case Name

220000 15400

Kitchen water piping,

grease trap system, and

steam lines

X HCA

220000 15400 Kitchen hot water heater X Morrison

220000 15400 Kitchen water piping X Morrison

220000 15400

Kitchen drainage sys.

(grease trap)

X Morrison

220000 15400 Kitchen hand sinks X Morrison

220000 15400 Plumbing – restroom X Grinalds

220000 15780 Thermal recovery system X La Petite Acad.

220000 15400

Plumbing connected to

equipment

X Boddie-Noelle

220000 15400 Plumbing for equipment X

Texas

Instruments

220000 15100 Plumbing to equipment X Duaine

220000 15100 Gas lines to equipment X Duaine

221100 15100 Plumbing system X Schrum

221200 13200 Water tanks X

Texas

Instruments

221300 11442 Kitchen grease trap X La Petite Acad.

223000 15480

Solar water-heating

equipment

X Wood

224000 15400

Special plumbing – dryer

gas lines

X AmeriSouth

224000 15400

Special plumbing – laundry

drain and waste lines

X AmeriSouth

224000 15400

Special plumbing – sinks

and garbage disposals

X AmeriSouth

224700 15412 Electric water coolers X Morrison

Division 23 – HVAC

Division 23 –

HVAC

Division 23 –

HVAC

Division 23 – HVAC

230000 15510 Steam boilers X HCA

230000 15850

Kitchen hoods & exhaust

system

X HCA

230000 15780 Kitchen heat recovery unit X Morrison

230000 15850 Kitchen air makeup unit X Morrison

90 | Page

CSI Master

Format 2004

Classification

CSI Master

Format 95

Classification

Asset

IRC

§1245

Prop.

IRC

§1250

Prop.

Case Name

230000 15700 Kitchen HVAC X Boddie-Noelle

230000 15700

Air conditioning in

telephone room

Texas

Instruments

230000 15764 Heating/ventilation system X L.L. Bean

230000 15700 Air conditioning units X Grinalds

230000 15700 HVAC system X Albertson’s

230000 15700 HVAC system X Publix

230000 15700 Air conditioning units (roof) X Circle K

230000 15700

Air conditioning/heating

units (roof)

X Dixie Manor

230000 15700 HVAC units X Piggly Wiggly

230000 15700 Blowers and coolers X Central Citrus

231300 13200 Fuel oil tanks X

Texas

Instruments

233000 15800

Special HVAC – dryer

vents

X AmeriSouth

233000 15800 Duct work (filter system) X Coors

235000

236000

15500

15600

Energy plant X Samis

236000 15600 Refrigeration system X SuperValu

237000 15700

Air conditioning/heating

system

X Samis

237000 15700

Air conditioning/heating

units (roof)

X Kramertown

237000 15700

Air conditioning/heating

system

X Fort Walton

Division 26 – Electrical

Division 26 –

Electrical

Division 26 –

Electrical

Division 26 – Electrical

260000 16200 TV equipment and wiring X HCA

260000 16140

Electrical conduits to

equipment

X Duaine

260000 16140 Electrical system X X Central Citrus

260000 16140

Elec. panel and

transformer

X Central Citrus

260000 16140 Electrical outlets X Central Citrus

91 | Page

CSI Master

Format 2004

Classification

CSI Master

Format 95

Classification

Asset

IRC

§1245

Prop.

IRC

§1250

Prop.

Case Name

260000 16200 Kitchen electrical service X La Petite Acad.

260000 16200 Elec. conduit – restroom X Grinalds

261000 16400 Electrical system X L.L. Bean

261000 16400

Primary & secondary elec.

dist. sys.

X X HCA

261000 16400

Special elec. equip. &

branch wiring

X HCA

261000 16400

Primary electric distribution

system

X X Morrison

261000 16400

Kitchen electric panel

boards

X Morrison

261000 16400 Electrical system X Schrum

261000 16400

Electrical distribution sys.

(95%/5%)

X X Ill. Cereal Mills

261000 16400

Primary electric distribution

system

X X Scott Paper

261000 16400

Secondary electric

distribution sys.

X X Scott Paper

261000 16400

Electrical connected to

equipment

X Boddie-Noelle

261000 16400

Electrical distribution

system

X A.C. Monk

261000 16400 Wiring for computer room X A.C. Monk

261000 16400

Elec. distribution system:

adapters, fuses, switches,

relays

X Central Citrus

261000 16400

Electrical – systems

dedicated to equipment

(Cat. 4)

Texas

Instruments

261000 16400

Electrical – spare

transformers, breakers,

cable (Cat. 3)

Texas

Instruments

261000 16400

Electrical – high voltage

system (Cat. 2)

Texas

Instruments

261100 16360

Electrical – substations and

transformers (Cat. 1)

Texas

Instruments

262000 16400 Special electric X X AmeriSouth

92 | Page

CSI Master

Format 2004

Classification

CSI Master

Format 95

Classification

Asset

IRC

§1245

Prop.

IRC

§1250

Prop.

Case Name

263000 16220

Electrical generating

equipment

X Westroads

265000 16500 Lighting fixtures and wiring X Walgreen

265100 16510 Over-bed fluorescent lights X HCA

265100 16510

Int. & ext. ornamental light

fixtures

X Duaine

265100 16510 Dock lighting X

Consol.

Freight.

265100 16510 Exterior accent lighting X

Metro Nat’l

Corp.

265100 16510 Interior grow lights X

Metro Nat’l

Corp.

265100 16510 Chandeliers and dimmers X Morrison

265100 16510 Chandeliers and lanterns X Shoney’s

265100 16510 Hanging lanterns X Shoney’s

265100 16510

Lights: fluorescent &

moisture-proof

X Central Citrus

265100 16510 Lights: ballast and exterior X Central Citrus

265200 16530 Emergency lighting X Morrison

265200 16530 Emergency/exit lights X La Petite Acad.

265600 16520 Exterior façade lighting X La Petite Acad.

265600 16520 Exterior security lighting X

Metro Nat’l

Corp.

265600 16510

Lights: spotlights and flood

lamps

X Central Citrus

Division 27 – Communication Division 27 – Communication

Division 27 –

Communication

Division 27 –

Communication

Division 27 –

Communication

Division 27 – Communication

270000 16700

Telephone equip., wiring,

and jacks

X HCA

270000 16700

Intercom equip. and call

system

X HCA

Div. 28 – Elec. Safety & Security

Div. 28 – Elec. Safety &

Security

Div. 28 – Elec. Safety &

Security

Div. 28 – Elec.

Safety & Security

Div. 28 – Elec.

Safety & Security

Div. 28 – Elec. Safety & Security

283100 15300 Heat and smoke detectors X La Petite Acad.

Division 31 – Earthwork

Division 31 –

Earthwork

Division 31 –

Earthwork

Division 31 – Earthwork

93 | Page

CSI Master

Format 2004

Classification

CSI Master

Format 95

Classification

Asset

IRC

§1245

Prop.

IRC

§1250

Prop.

Case Name

311000 02200

Site prep and earthwork

(nondep.)

AmeriSouth

Division 32 – Ext.

Improvements

Division 32 – Ext.

Improvements

Division 32 – Ext.

Improvements

Division 32 – Ext.

Improvements

Division 32 – Ext.

Improvements

Division 32 – Ext. Improvements

323000 02800 Trellises (§1245) X Trentadue

323100 02825 Security fencing X

Texas

Instruments

323100 02825 Fencing – playground X La Petite Acad.

323100 02825

Dumpster enclosure (fence

& concrete pad)

X La Petite Acad.

328000 02810 Sprinkler heads X

Metro Nat’l

Corp.

328423 02810

Underground irrigation

system

X Trentadue

329300 02930 Exterior landscaping X

Texas

Instruments

329300 02930 Interior landscaping X

Texas

Instruments

Division 33 – Utilities

Division 33 –

Utilities

Division 33 –

Utilities

Division 33 – Utilities

331116 02510 Water distribution system X AmeriSouth

332100 02520 Well X Trentadue

333000 02530 Sewage disposal system X Everhart

333100 02530 Sanitary sewer system X AmeriSouth

335100 02550 Gas line X AmeriSouth

337100 02580 Site electric X AmeriSouth

94 | Page

5. Table 3: Listing of CSI MasterFormat Divisions (2004 and 1995)

MASTERFORMAT 2004 EDITION

The current MasterFormat Divisions are:

PROCUREMENT AND CONTRACTING REQUIREMENTS GROUP

• Division 00 — Procurement and Contracting Requirements

SPECIFICATIONS GROUP

General Requirements Subgroup

• Division 01 — General Requirements

Facility Construction Subgroup

• Division 02 — Existing Conditions (natural conditions)

• Division 03 — Concrete (footing)

• Division 04 — Masonry (concrete block/brick)

• Division 05 — Metals (beams)

• Division 06 — Wood, Plastics, and Composites (framing)

• Division 07 — Thermal and Moisture Protection (insulation water barrier)

• Division 08 — Openings (doorways)

• Division 09 — Finishes

• Division 10 — Specialties

• Division 11 — Equipment

• Division 12 — Furnishings

• Division 13 — Special Construction

• Division 14 — Conveying Equipment

• Division 15 — RESERVED FOR FUTURE EXPANSION

• Division 16 — RESERVED FOR FUTURE EXPANSION

• Division 17 — RESERVED FOR FUTURE EXPANSION

• Division 18 — RESERVED FOR FUTURE EXPANSION

• Division 19 — RESERVED FOR FUTURE EXPANSION

Facility Services Subgroup:

• Division 20 — RESERVED FOR FUTURE EXPANSION

• Division 21 — Fire Suppression

• Division 22 — Plumbing

• Division 23 — Heating Ventilating and Air Conditioning

• Division 24 — RESERVED FOR FUTURE EXPANSION

• Division 25 — Integrated Automation

• Division 26 — Electrical

• Division 27 — Communications

• Division 28 — Electronic Safety and Security

• Division 29 — RESERVED FOR FUTURE EXPANSION

Site and Infrastructure Subgroup:

• Division 30 — RESERVED FOR FUTURE EXPANSION

• Division 31 — Earthwork

• Division 32 — Exterior Improvements

• Division 33 — Utilities

• Division 34 — Transportation

• Division 35 — Waterway and Marine

• Division 36 — RESERVED FOR FUTURE EXPANSION

• Division 37 — RESERVED FOR FUTURE EXPANSION

• Division 38 — RESERVED FOR FUTURE EXPANSION

• Division 39 — RESERVED FOR FUTURE EXPANSION

95 | Page

Process Equipment Subgroup:

• Division 40 — Process Integration

• Division 41 — Material Processing and Handling Equipment

• Division 42 — Process Heating, Cooling, and Drying Equipment

• Division 43 — Process Gas and Liquid Handling, Purification and Storage Equipment

• Division 44 — Pollution and Waste Control Equipment

• Division 45 — Industry-Specific Manufacturing Equipment

• Division 46 — Water and Wastewater Equipment

• Division 47 — RESERVED FOR FUTURE EXPANSION

• Division 48 — Electrical Power Generation

• Division 49 — RESERVED FOR FUTURE EXPANSION

6. MASTER FORMAT 1995 EDITION

Before November 2004, MasterFormat was composed of 16 primary divisions:

• Division 01 — General Requirements

• Division 02 — Site Construction

• Division 03 — Concrete

• Division 04 — Masonry (concrete block)

• Division 05 — Metals(beams)

• Division 06 — Wood and Plastics

• Division 07 — Thermal and Moisture Protection

• Division 08 — Doors and Windows

• Division 09 — Finishes

• Division 10 — Specialties

• Division 11 — Equipment

• Division 12 — Furnishings

• Division 13 — Special Construction

• Division 14 — Conveying Systems

• Division 15 — Plumbing & Mechanical

• Division 16 — Electrical

96 | Page

E. Inherently Permanent Standard

1. Introduction

In determining whether a structure, or component of a structure, is inherently permanent,

one must consider the governing code section defining the scope and nature of the

structure. Chapter 2.L of this ATG discusses whether a structure is inherently permanent

for cost recovery purposes under § 168. The analysis used for inherent permanency for

cost recovery purposes under § 168 is not the same as for other code sections that use the

“inherently permanent” concept. This includes the Uniform Capitalization (UNICAP) rules of

§ 263A (discussed in Chapter 6.A of this ATG) and the Domestic Production Deduction

(DPD) rules of § 199. The “inherently permanent” rules for each of these other code

sections are markedly different from those for cost recovery. Care should be taken when

evaluating a cost segregation study that the correct “inherently permanent” rules are

applied. To assist the examiner to recognize the differences between each code section, a

brief summary of these provisions is presented below.

2. Inherently Permanent Standard Under § 168

The primary issue in cost segregation studies is the proper classification of assets as either

§ 1245 or § 1250 property. The definitions of property for purposes of §§ 1245 and 1250

are essential for determining eligibility for a number of other Code provisions (including

§§ 167, 168, 179, and former § 48). Treas. Reg. § 1.1245-3 defines "tangible personal

property," "other tangible property," "building," and "structural component" by reference to

Treas. Reg. § 1.48-1. This regulation relates to former § 48 which was enacted in 1962

along with §§ 1245 and 1250. Former § 48 allowed an investment tax credit (ITC) based on

the "applicable percentage" of the investment in eligible property placed in service during

the taxable year. Eligible property included tangible personal property (other than heating

or air conditioning units) and other tangible property (primarily machinery and equipment

used in specific business activities) that was closely integrated into the taxpayer's trade or

business. Land, buildings, structural components contained in or attached to buildings, and

other inherently permanent structures generally were not eligible for ITC.

Treas. Reg. § 1.48-1(c) defines 'tangible personal property' as any tangible property except

land and improvements thereto, such as buildings or other inherently permanent structures

(including items which are structural components of such buildings or structures). Thus,

buildings, swimming pools, paved parking areas, wharves and docks, bridges, and fences

are not tangible personal property. Tangible personal property includes all property (other

than structural components) which is contained in or attached to a building. Thus, such

property as production machinery, printing presses, transportation and office equipment,

refrigerators, grocery counters, testing equipment, display racks and shelves, and neon and

other signs, which is contained in or attached to a building constitutes tangible personal

property for purposes of the ITC. Further, all property that is in the nature of machinery

(other than structural components of the building or other inherently permanent structure) is

considered tangible personal property even though located outside a building. Thus, for

97 | Page

example, a gasoline pump, hydraulic car lift or automatic vending machine, although

annexed to the ground, is considered tangible personal property.

Treas. Reg. § 1.48-1(c) also provides that local law is not controlling for purposes of

determining whether property is or is not “tangible” or “personal”. Thus, the fact that under

local law property is held to be personal property or tangible property is not controlling.

Conversely, property may be personal property for purposes of the ITC even though under

local law the property is considered to be a fixture and therefore real property.

Treas. Reg. § 1.48-1(d) provides that in addition to tangible personal property, any other

tangible property (but not including a building and its structural components) used as an

integral part of manufacturing, production, or extraction, or as an integral part of furnishing

transportation, communications, electrical energy, gas, water, or sewage disposal services

by a person engaged in a trade or business of furnishing any such service, or which

constitutes a research or storage facility used in connection with any of the foregoing

activities, may qualify for the ITC. This regulation essentially provides that inherently

permanent structures (but not a building and its structural components) used in certain

business activities will be deemed eligible for the ITC.

Treas. Reg. § 1.48-1(e)(1) defines a "building" as any structure or edifice enclosing a space

within its walls, and usually covered by a roof, the purpose of which is, for example, to

provide shelter or housing, or to provide working, office, parking, display, or sales space.

The term includes, for example, structures such as apartment houses, factory and office

buildings, warehouses, barns, garages, railway or bus stations, and stores. Such term

includes any such structure constructed by, or for, a lessee even if such structure must be

removed, or ownership of such structure reverts to the lessor, at the termination of the

lease.

Specifically excluded from the definition of the term "building" are: (i) a structure which is

essentially an item of machinery or equipment, or (ii) a structure which houses property

used as an integral part of an activity specified in former § 48(a)(1)(B)(i) if the use of the

structure is so closely related to the use of such property that the structure clearly can be

expected to be replaced when the property it initially houses is replaced. Factors which

indicate that a structure is closely related to the use of the property it houses include the

fact that the structure is specifically designated to provide for the stress and other demands

of such property and the fact that the structure could not be economically used for other

purposes. Thus, the term “building” does not include such structures as oil and gas storage

tanks, grain storage bins, silos, fractionating towers, blast furnaces, basic oxygen furnaces,

coke ovens, brick kilns, and coal tipples.

Treas. Reg. § 1.48-1(e)(2) provides that "structural components" includes such parts of a

building as walls, partitions, floors, and ceilings, as well as any permanent coverings

therefor such as paneling or tiling; windows and doors; all components (whether in, on, or

adjacent to the building) of a central air conditioning or heating system, including motors,

compressors, pipes and ducts; plumbing and plumbing fixtures, such as sinks and

bathtubs; electric wiring and lighting fixtures; chimneys; stairs, escalators, and elevators,

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including all components thereof; sprinkler systems; fire escapes; and other components

relating to the operation or maintenance of a building.

In Revenue Ruling 75-178, 1975-1 C.B. 9, the Service stated, “the problem of classification

of property as ‘personal’ or ‘inherently permanent’ should be made on the basis of the

manner of attachment to the land or the structure and how permanently the property is

designed to remain in place.” Thus, the test to be used to determine whether an asset is

tangible personal property is the inherently permanent test.

The seminal case involving the determination of whether an asset is inherently permanent

for purposes of § 168 and former § 48 is Whiteco Industries, Inc. v. Commissioner, 65 T.C.

664 (1975). The Tax Court noted that “tangible personal property” is not intended to be

defined narrowly nor to follow the rules of State law where fixation to the land is a basis for

distinguishing personal property from other property. Based on an analysis of prior case

law, the Tax Court put forth six questions designed to ascertain whether a particular asset

qualifies as tangible personal property. These questions, also referred to as the "Whiteco

factors," are:

1. Is the property capable of being moved, and has it in fact been moved?

2. Is the property designed or constructed to remain permanently in place?

3. Are there circumstances which tend to show the expected or intended length of

affixation, i.e., are there circumstances which show that the property may or will have

to be moved?

4. How substantial a job is removal of the property and how time-consuming is it? Is it

“readily removable”?

5. How much damage will the property sustain upon its removal?

6. What is the manner of affixation of the property to the land?

It should be noted that movability itself is not determinative in measuring permanence. The

Whiteco court held that affixation to land does not per se exclude the property from the

category of tangible personal property. Inversely, in L.L. Bean, Inc. v. Commissioner, T.C.

Memo. 1997-175, aff'd, 145 F.3d 53 (1st Cir. 1998), the court held that the mere fact that a

structure is theoretically capable of being moved does not conclusively establish that it is

not inherently permanent.

Examiners should also consider the following additional factors when addressing

permanency (some of which may overlap with the Whiteco factors):

• the history of the item or similar items being moved;

• the manner in which an item is attached to a building or to the land;

• the weight and size of the item;

• the function and design of the item;

• the intent of the taxpayer in installing the item;

• the time, cost, manpower, and equipment required to move the components;

• the time, cost, manpower, and equipment required to reconfigure the existing space if

the item is removed;

• the effect of the item’s removal on the building; and

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• the extent the item can be reused after removal.

See AmeriSouth XXXII, Ltd. V. Commissioner, T.C. Memo. 2012-67; Trentadue v.

Commissioner, 128 T.C. 91 (2007); PDV America, Inc. and Subs. v. Commissioner, T.C.

Memo. 2004-118; Hospital Corp. of America and Subs. v. Commissioner, 109 T.C. 21

(1997).

Further detail and updates can be obtained from the Depreciable and Capital Expenditures

Practice Network.

3. Inherently Permanent Standard Under § 263A

The uniform capitalization (UNICAP) rules require the capitalization of all direct costs and

certain indirect costs properly allocable to real property and tangible personal property

produced by the taxpayer. Included in this is the capitalization of interest expense when the

taxpayer produces certain property. See § 263A(f) and Treas. Reg. § 1.263A-8. For tax

years beginning after December 31, 2017, small business taxpayers (previously defined)

are not required to capitalize costs including interest under § 263A.

Producers must capitalize costs (other than interest) whether incurred before, during, or

after the production period of property. Pre-production costs are subject to capitalization if

the property is held for future production or if it is reasonably likely that the property will be

produced at a future date. Thus, costs of storing raw materials and carrying costs of realty

held for development are required to be capitalized. Production period costs are costs

incurred beginning on the date on which production of the property begins and ending on

the date on which the property is ready to be placed in service or is ready to be held for

sale. Post-production costs are costs incurred after the actual production and may include

costs of storage, warehousing, insurance, materials, and handling.

In contrast, interest is only capitalized during the production period of property. Treas. Reg.

§§ 1.263A-8 through 1.263A-15 provide guidance with respect to the capitalization of

interest under § 263A(f). These regulations are effective for 1995 and after, or at taxpayer's

election, 1994. For years prior to the effective date of these regulations, see Notice 88-99,

1988-2 C.B. 422, as well as the prior temporary regulations, which provide guidance with

respect to the capitalization of interest.

For purposes of UNICAP, interest is capitalized with respect to each unit of designated

property. Designated property is defined in § 263A(f)(1) and Treas. Reg. § 1.263A-8(b)(1).

Designated property is any property that is produced that constitutes: i) real property; or ii)

tangible personal property which meets any of the following criteria: A) property with a class

life of 20 years or more that is not inventory in the hands of the taxpayer or a related

person; B) property with an estimated production period exceeding 2 years; or C) property

with an estimated production period exceeding 1 year and an estimated cost of production

exceeding $1,000,000. Note that all real property is subject to the rules of § 263A(f); the

listed criteria only apply to tangible personal property. The criteria are applied individually to

each unit of property.

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Treas. Reg. § 1.263A-8(c)(1) defines real property. Real property includes land, un-severed

natural products of land, buildings, and inherently permanent structures. Any interest in real

property, including fee ownership, co-ownership, a leasehold, an option, or a similar

interest is real property. Real property includes the structural components of both buildings

and inherently permanent structures, such as walls, partitions, doors, wiring, plumbing,

central air conditioning and heating systems, pipes and ducts, elevators and escalators,

and other similar property. Tenant improvements to a building that are inherently

permanent are real property.

Treas. Reg. § 1.263A-8(c)(3) provides that inherently permanent structures include

property that is affixed to real property and that will ordinarily remain affixed for an indefinite

period of time. Examples include swimming pools, roads, bridges, tunnels, paved parking

areas and other pavements, special foundations, wharves and docks, fences, inherently

permanent advertising displays, inherently permanent outdoor lighting facilities, railroad

tracks and signals, telephone poles, power generation and transmission facilities,

permanently installed telecommunications cables, broadcasting towers, oil and gas

pipelines, derricks and storage equipment, grain storage bins and silos. For purposes of

this section, affixation to real property may be accomplished by weight alone.

Treas. Reg. § 1.263A-8(c)(3) further provides that property may constitute an inherently

permanent structure even though it is not classified as a building for purposes of Treas.

Reg. § 1.48-1(e). Additionally, any property that constitutes “other tangible property” under

the principles of Treas. Reg. § 1.48-1(d) is treated as an inherently permanent structure.

Treas. Reg. § 1.263A-8(c)(4) provides that a structure that is property in the nature of

machinery or is essentially an item of machinery or equipment is not an inherently

permanent structure and is not real property. In the case, however, of a building or

inherently permanent structure that includes property in the nature of machinery as a

structural component, the property in the nature of machinery is real property. A structure

may be an inherently permanent structure, and not property in the nature of machinery or

essentially an item of machinery, even if the structure is necessary to operate or use,

supports, or is otherwise associated with, machinery. The purpose of this regulation is to

prevent the definition of “property in the nature of machinery” from including inherently

permanent structures that support or are otherwise necessary to the operation of that

machinery such as ski lift towers and offshore oil platforms.

Treas. Reg. § 1.263A-10(b) provides that real property includes any components of real

property owned by the taxpayer that are functionally interdependent. Components of real

property are functionally interdependent if the placing in service of one component is

dependent on the placing in service of the other component by the taxpayer or a related

person.

4. Comparison of Inherently Permanent Standard Under §§ 168 and 263A

The principles and tests used to determine whether an item of property is tangible personal

property under Treas. Reg. § 1.48-1(c) (and thus to determine whether the item qualifies as

§ 1245 property) do not apply in determining whether such item of property is tangible

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personal property or real property for purposes of § 263A(f). IRS CCA 200648026.

Accordingly, property classified as depreciable tangible personal property for purposes of §

168 can be either real property or tangible personal property for purposes of the “avoided

cost” interest capitalization calculation under § 263A(f). A determination of whether interest

is capitalized with respect to a unit of designated property is made under the principles of §

263A(f) and the regulations thereunder and is not controlled by the characterization of

property for purposes of § 168.

Similarly, the classification of the property for purposes of § 263A(f) does not control its

classification for purposes of cost recovery under § 168. Id. Interest capitalized under

§ 263A(f) is treated as a cost of the designated property produced; cost recovery is

determined by the applicable Code and regulatory provisions relating to the use, sale, or

disposition of property.

There are five primary aspects to how the definition of inherently permanent differs

between §§ 168 and 263A.

First, whereas Treas. Reg. § 1.48-1(c) contains the principle that the classification of

property under local law is irrelevant to the classification of property for purposes of the ITC

(and § 1245 property), the local law characterization of an item of property can be a

relevant consideration in the classification of property as either tangible personal property

or real property for purposes of § 263A(f). IRS CCA 200648026.

Second, whereas the legislative intent regarding the ITC favors a broad construction of

“tangible personal property,” the legislative history of § 263A(f) contains nothing to indicate

that Congress intended the broad construction of tangible personal property under the ITC

to apply to interest capitalization under § 263A(f). IRS CCA 201211011.

Third, an item of property that does not qualify as a structural component under the ITC

scheme because it does not relate to the operation or maintenance of a building, may

constitute a structural component of the building (and thus real property) for purposes of

§ 263A since there is no requirement under § 1.263A-8(c) that the item of property relate to

the operation and maintenance of a building. The property, however, still must otherwise

possess sufficient indicia of being a structural component to be classified as such. IRS

CCA 200648026.

Fourth, although the definition of inherently permanent structures in Treas. Reg. § 1.263A-

8(c)(3) references “other tangible property” under Treas. Reg. § 1.48-1(d) as a type of

inherently permanent structure, an item of property may be an inherently permanent

structure for purposes of UNICAP even though it would not have been an inherently

permanent structure (and thus not “other tangible property”) for purposes of the ITC. IRS

CCA 201211011.

Fifth, the specific nature of the limitations on the machinery exclusion in Treas. Reg.

§ 1.263A-8(c)(4) (as well as language in the preamble to the regulation) indicates that the

provision was intended to reject a specific line of ITC cases and rulings that greatly

expanded the definition of what constitutes property in the nature of machinery under

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Treas. Reg. § 1.48-1(c). Thus, inherently permanent structures that support or are

otherwise necessary to the operation of that machinery are inherently permanent for

purposes of UNICAP. IRS CCA 201211011.

Within the context of a cost segregation study, sometimes building systems such as

electrical distribution and plumbing systems are deemed to be “dual purpose” for cost

recovery purposes. Thus, for purposes of § 168, the portion of the cost of the building

system corresponding to the percentage allocable to equipment constitutes tangible

personal property (§ 1245 property) whereas the portion corresponding to building

operation and maintenance constitutes structural components (§ 1250 property). As stated

above, however, the fact that costs are characterized as tangible personal property for

purposes of § 168 is not sufficient in itself to establish that these costs do not constitute real

property for purposes of capitalizing interest under § 263A(f). Building systems are

functionally interdependent with the building in which they are installed such that a building

and its building systems are part of the same unit of real property for purposes of Treas.

Reg. § 1.263A-10. Splitting a building system into two units of property for purposes of §

263A(f) would be contrary to the functional interdependence test underlying the concept of

unit of property in the avoided cost regulations. Moreover, no provision is made for real

property components and tangible personal property components combining into a single

property unit; a unit of property under Treas. Reg. § 1.263A-10 must either be a real

property unit (consisting entirely of real property components) or a tangible personal

property unit (consisting entirely of tangible personal property components). Accordingly,

allocating the cost of a building system such as an electrical distribution or plumbing

system between real property and tangible personal property is inconsistent with § 263A(f).

Further detail and updates can be obtained from the Inventory and 263A PN.

5. Inherently Permanent Standard Under § 199

The Domestic Production Deduction (DPD) was enacted effective for taxable years

beginning after December 31, 2004 and was intended to motivate domestic economic

growth. The DPD was repealed by the Tax Cuts and Jobs Act P.L. 115-97 (as amended by

the Consolidated Appropriations Act, 2018, Public Law 115-141, § 101(c), 132 Stat. 348,

1151, 1156) for taxable years beginning after December 31, 2017. The DPD is determined

by applying a percentage to the lesser of a taxpayer’s qualified production activities income

(QPAI) or taxable income. The applicable percentage is 3 percent for taxable years 2005

and 2006, 6 percent for taxable years 2007 through 2009, and 9 percent for taxable years

beginning after 2009. § 199(a).

QPAI is determined by taking domestic production gross receipts (DPGR) less cost of

goods sold (COGS) and other expenses allocable to such DPGR. DPGR includes gross

receipts derived from any lease, rental, license, sale, exchange or other disposition of

qualifying production property (QPP) which was manufactured, produced, grown or

extracted by the taxpayer in whole or in significant part within the United States. §

199(c)(4)(A)(i)(l). QPP means tangible personal property, computer software and sound

recordings. § 199(c)(5). DPGR also includes gross receipts from the construction of real

property in the United States by a taxpayer in the normal course of a construction trade or

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business. § 199(c)(4)(A)(ii). DPGR also includes gross receipts from engineering or

architectural services performed in the United States with respect to the construction of real

property. § 199(c)(4)(A)(iii) and Treas. Reg. § 1.199-3(n).Treas. Reg. § 1.199-3(j)(2)

defines tangible personal property as any tangible property other than land, real property

described in Treas. Reg. § 1.199-3(m)(3), and property described in other sections of the

regulation (computer software, sound recordings, qualified films, electricity, natural gas,

and potable water). Property such as machinery, printing presses, transportation and office

equipment, refrigerators, grocery counters, testing equipment, display racks and shelves,

and neon and other signs that are contained in or attached to a building constitutes tangible

personal property for purposes of § 199. In determining whether property is tangible

personal property, local law is not controlling.

Treas. Reg. § 1.199-3(m)(3) defines real property as buildings (including items that are

structural components of such buildings), inherently permanent structures (as defined in

Treas. Reg. § 1.263A-8(c)(3)) other than machinery (as defined in Treas. Reg. § 1.263A-

8(c)(4)) (including items that are structural components of such inherently permanent

structures), inherently permanent land improvements, oil and gas wells, and infrastructure.

Treas. Reg. § 1.199-3(m)(4) defines the term infrastructure to include roads, power lines,

water systems, railroad spurs, communications facilities, sewers, sidewalks, cable, wiring,

and inherently permanent oil and gas platforms. For purposes of § 199, structural

components of building and inherently permanent structures include property such as walls,

partitions, doors, wiring, plumbing, central air conditioning and heating systems, pipes and

ducts, elevators and escalators, and other similar property. Treas. Reg. § 1.199-3(m)(3).

Accordingly, the definition of an inherently permanent structure is the same for § 199 as it is

for § 263A(f). In other words, the same rules that determine what constitutes an inherently

permanent structure for UNICAP purposes described above also apply to determine

whether property qualifies as QPP. The result of using these rules is that if property is

determined to be an inherently permanent structure under Treas. Reg. § 1.263A-8(c)(3), it

is real property for purposes of § 199 and Treas. Reg. § 1.199-3(m)(3), is not QPP, and

the gross receipts and allocable expenses derived from the property can only be used to

determine DPGR and QPAI if the taxpayer meets the rules in Treas. Reg. § 1.199-3(m)(6)

related to deriving gross receipts from the construction of real property performed in the

United States, or the rules in Treas. Reg. § 1.199-3(n) related to engineering or

architectural services. Note that, per Treas. Reg. § 1.199-3(m)(6)(iii), DPGR derived from

the construction of real property performed in the United States does not include gross

receipts derived from the sale, exchange, or other disposition of real property acquired by

the taxpayer even if the taxpayer originally constructed the property. In addition, DPGR

derived from the construction of real property does not include gross receipts from the

lease or rental of real property constructed by the taxpayer.

6. Comparison of Inherently Permanent Standard Under §§ 168 and 199

In IRS CCA 201302017, the Service considered whether a variety of outdoor advertising

displays constituted inherently permanent structures and were therefore real property when

determining QPP for purposes of § 199. It noted that the definition of an inherently

permanent structure in Treas. Reg. § 1.263A-8(c)(3) establishes two basic criteria for an

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inherently permanent structure: first, it is affixed to real property; second, it will ordinarily

remain affixed for an indefinite period of time.

The term “affixed to real property” under § 1.263A-8(c)(3) is understood pursuant to its

ordinary and common sense meaning, that is, physically connected or attached. Affixation

to real property may be accomplished by weight alone. Embedding a structure in the

ground can establish attachment to real property. Mounting a structure to a foundation also

can accomplish adequate connection to real property. Similarly, affixation may be achieved

when the means of connection secure a structure to real property to withstand severe

weather conditions. If installation of the structure involves the use of construction

machinery and equipment, attachment to real property may be indicated.

The term “ordinarily remain affixed for an indefinite period of time” under § 1.263A-8(c)(3)

means that the structure will typically remain affixed to real property for the period during

which the structure is expected to remain in operating condition and serve a useful function,

in other words, the useful life inherent in the structure. In general, the structure is attached

without any fixed plan to remove it at a particular date in the future, and the exact date

when the structure will be removed is neither known nor knowable when it is affixed.

Additionally, the possibility or occurrence of temporary or permanent removal from real

property (such as from hurricane force winds) does not transform the intrinsically

permanent nature of a structure.

Practices of an industry or taxpayer also may be instructive as to whether a particular

structure or type of structure is inherently permanent. Therefore, a definite lease term may

be ignored if it is customary for the industry to renew the lease until the structure’s inherent

useful life is exhausted or the structure is no longer profitable. Lastly, the amount of time

and expense involved in affixing the structure to be able to function also should be

considered.

Unlike the Whiteco factors for determining whether an item of property is an inherently

permanent structure for cost recovery purposes, for purposes of § 199 it is irrelevant that

the means of connection permit removal without damage to the structure. For example, a

structure attached by weight alone is likely removable without damage. Similarly, a

structure bolted to a cement foundation that is embedded in the ground is likely removable

without damage but nevertheless is connected to real property. Note, however, that the

manner of affixation should sufficiently secure the structure so that it will remain in place to

be able to perform its intended function.

In short, an item is an inherently permanent structure for purposes of § 199 “when it is

attached to real property and will ordinarily remain connected to real property to be able to

perform its intended function.” IRS CCA 201302017.

Further detail and updates concerning using the Inherently Permanent rules within § 199

can be obtained from the Corporate Income and Losses PN.

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7. Conclusion

In determining whether a structure, or component of a structure, is inherently permanent,

one must consider the context and governing code section. The analysis used to determine

whether an item is inherently permanent for cost recovery purposes under § 168 (or for ITC

purposes under former § 48) is not the same as the analysis for UNICAP purposes under

§ 263A and DPD purposes under § 199. As a consequence, the “inherently permanent”

rules for cost recovery are markedly different from those for the other code sections.

For cost recovery purposes, the Whiteco factors were designed in light of legislative history

indicating that “tangible personal property” was intended to be broadly defined and that the

rules of State law where fixation to the land is a basis for distinguishing personal property

from other property were not to be followed. Thus, the standard for determining whether an

item of property is inherently permanent for purposes of cost recovery is relatively narrow.

In contrast, the standard for whether an item is inherently permanent for purposes of

UNICAP and DPD follows its ordinary and common sense meaning, namely that fixation to

the land is sufficient provided the item of property will remain in operating condition and

serve a useful function over the useful life inherent in the structure. Hence, the standard for

determining whether an item of property is inherently permanent for purposes of UNICAP

and DPD is broader than the standard for cost recovery. Care should be taken when

evaluating a cost segregation study that the correct “inherently permanent” rules are

applied.

F. Construction Process

1. Introduction

A cost segregation study is typically completed using information that was developed for

the construction process. This information includes drawings, specifications, and supplier

and contractor payment documents. To better understand how a cost segregation study is

conducted, it is helpful to understand this process. The following discussion provides a

general overview of this process, from the conceptual stage through the bidding,

construction, payment, and completion stage of a project. Although there may be certain

facts and circumstances in specific geographic locales that vary from what is presented

here, the basic construction concepts are similar in all locales. For purposes of this

discussion, it is assumed that a fee contractor, rather than an in-house labor force,

performs the construction. For additional information and a glossary of construction terms,

refer to the LB&I Construction Industry or the Construction Industry Audit Techniques

Guide.

2. Stages in the Construction Process

The Construction Process is composed of six distinct stages; each of these stages is

discussed below in more detail.

1. Concept

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All construction projects begin with planning and design, also referred to as "architectural

programming." Numerous overlapping steps occur during this conceptual or design phase,

prior to actual construction of the project.

An architect is the primary designer of a building or project and controls the overall design,

specifications, finished materials (e.g., brick, paint, carpet, wall covering, etc.), and other

architectural features of the building. In addition, the architect supervises the engineers

responsible for the structural, mechanical, electrical, lighting, plumbing and

communications system design of the building. Engineers must always conform to the

design requirements of the architect. Each member of the design team must also be

licensed with the proper state licensing authorities where the facility is located.

Planning & Architectural Programming

During the initial stages of the design process, the architect(s) and engineer(s) have a

number of client meetings to determine the purpose and objective of the proposed

construction. The primary activities, for which the project is being constructed, as well as

the relationships between spaces, are reviewed. Consideration is also given to how well the

completed project relates to adjacent buildings (if any) and its surroundings. The

preliminary programming produces a list of solutions, alternatives, feasibility studies and

costs estimates. After a review of the programming statement, schematic plans are

prepared.

Schematic Plans

Schematic plans are the first plans of a facility and show the interrelationship between

spaces and activities. All of the parties (architects, engineers and the client) review the

schematic plans and make recommendations, as necessary. Any changes are then

incorporated into the final schematic plans. Revised schematic plans are also known as

"preliminary plans," and provide a graphic view of the project, the refined details of how the

project will look, and the relationship of all spaces.

Once the preliminary planning phase is complete, the project then enters a stage involving

the preparation of contract bid documents and working drawings.

2. Contracts and Bid Documents

The construction contractor(s) are normally selected through a competitive bidding process,

but may also be selected via negotiation. To solicit construction bids, the builder must

provide potential bidders with: a) Working drawings and plans for the proposed structure,

as well as b) Project specifications. These are called the “construction documents” and

offer a complete and detailed set of information to communicate all the required items

within a building project.

2a. Working Drawings

Contract/Working Drawings/Plans

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All projects, whether they involve new construction or the expansion of an existing

structure, require the preparation of contract documents. The contract working drawings

and plans provide a pictorial representation of the construction work, and specify or lay out

the designer’s intentions for the facility. The drawings illustrate, among other things, the

appearance, layout, equipment, and amenities of the project. These drawings show the

architect’s plan/design for the building’s overall appearance, such as finish materials, floor

plans, sizes and use of each building area. In contrast, engineers design the building’s

structural, mechanical, electrical, plumbing and communication systems.

The architect also begins to gather project data to deal with problems or situations that are

expected to arise during the construction process, such as local zoning requirements, local

infrastructure, traffic, environmental and population impact, acoustic, energy, lighting, and

aesthetic considerations. Various consulting engineers may also be utilized to solve

specific project problems.

The following are examples of the numerous drawing plans that may be involved in a

construction project.

Architectural Drawings

The architectural drawings (or “Plans”) indicate the layout of the project, such as floor

plans, elevations, sections, and details of the construction and architectural finishes. These

plans are typically numbered sequentially with the prefix "A" for "architectural." The most

common type of an architectural plan is an overhead view of the spaces on a specific floor.

These plans also indicate the length, width and various heights of the structure and floor

elevations. Plans may show notes of specific construction information and may contain

details on a specific portion of work.

Exterior elevations show the exterior and the exterior finishes, and are similar to

photographs of the exterior. Architectural schedules on the plans indicate the door types,

windows, hardware, plumbing, and light fixtures in each room.

In preparing the plans, the architect utilizes graphic symbols, instead of words, to indicate

various facility conditions. These symbols indicate the various types of material, sizes, and

room finishes to be used. Symbols may be shown on the plans themselves or in the

legends of the plans. [A list of general symbols is shown in the Appendix of Plan Reading

and Material Takeoff, by Wayne J. DelPico, published by R. S. Means Company.]

Site Plans

A civil engineer is responsible for the proper drainage of a site, as well as the design of

land improvements, such as paving, curb and gutter design, retaining walls, and drainage

culverts. Site plans prepared by the civil engineer indicate the existing and proposed

grades of the land and the specific location of the facility on the land.

Structural Plans

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The structural plans are prepared by structural engineers and show the structural design of

a building. These plans incorporate foundation planning with considerations for rain, snow,

wind, earthquakes, and other natural phenomena. Structural engineers design the facility

for both "live" and "dead" loads of the building. Live loads consist of the people, furniture

and other items that are not part of the building, but are supported by the building. Dead

load is simply the weight of the building or structure itself.

Mechanical Plans

Mechanical plans are prepared by a mechanical engineer to show the design of the various

mechanical systems in the building. These systems must be designed to incorporate the

proper air conditioning, heating, and ventilation equipment, as well as adequate plumbing,

to meet the needs for all of the building’s designated activities.

Like the structural engineer, the mechanical engineer must design the mechanical building

systems to meet building "loads". For example, office work produces a certain level of heat

load, whereas cooking in a commercial kitchen may produce greater heat loads. The

energy use of the air conditioning, heating, pumps, and other building equipment are

monitored by the mechanical engineer and are considered when specifying building

equipment for an efficiently designed building system. Mechanical plans are numbered with

the prefixes "P" for "plumbing" and "H" for "heating, ventilating and air conditioning."

Electrical Plans

An electrical engineer prepares electrical plans to show the electrical distribution system for

the efficient distribution of power in a building. The plan design includes the distribution of

electrical power from the utility company and the distribution to power-specific equipment.

Engineering design factors for the overall electrical "load" of a building must also be

considered (e.g., proper sizing and arrangement of transformers, panel boards, circuits,

wires, conduits and power to the various machines, equipment and activities in the

building). Electrical engineers may also handle the lighting design requirements of the

building, as well as specialty areas such as a central security monitoring system, a

computerized control system, and fire and smoke management systems. Electrical plans

are numbered with the prefix "E" for "electrical."

Communications

There may be several other sets of plans that detail the layout of special communications

systems. For instance, the fire and security systems, network computers system, telephone

and communications systems, media and entertainment systems could be shown on a

separate set of plans. All of these plans could be included with the bid documents or be a

separate contract all together. If there is a specific issue that arises during your

examination of a cost segregation study that concerns one of these communications

systems, be sure to ask for them in addition to the other sets of plans of your subject

building.

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2b. Specifications and Other Written Construction Documents

Contract Specifications

The second part of the contracts and bid documents stage is the preparation of project

specifications, also known as "specs." Specs instruct the contractor on how to build the

project, and consist of contract documents, the technical specifications of the materials and

the quality of the materials to be installed, and the workmanship for installation of the

materials. Given the amount of information that is required to be included, specs have to be

organized in a coherent manner. The most widely accepted system for arranging

construction specifications is the “CSI MasterFormat.” The CSI format, developed by the

Construction Specification Institute, requires four categories of information: bidding

requirements, contract forms, contract conditions, and technical specifications.

Bidding requirements

Bidding requirements describe the conditions of the bid to the owner, and encompass the

Invitation to Bid, the Instructions to Bidders, the Information Available to Bidders, the Bid

Forms and Attachments, and the Bid Security Forms. The type of contract between an

owner and a contractor dictates the form of the bidding conditions.

Contract Form

Contract forms are divided into sections, including the Agreement, the Performance and

Payment Bonds, and the Certificates.

Contract Conditions

The contract conditions include the General Conditions and Supplementary Conditions.

Technical Specifications

Technical specs are generally prepared for each specific project in the CSI MasterFormat

(see below) and these include hundreds, perhaps thousands of individual items that will be

installed in a project. The CSI MasterFormat have been modified (2004) to include many

more divisions included for electrical and communication systems to accommodate current

trades and systems now included in most buildings.

2b(i). Construction Specifications Institute (CSI) MasterFormat

The Construction Specifications Institute (CSI) is a national organization dedicated to the

standardization and improvement of construction specifications. The CSI MasterFormat is a

master list of numbers and titles classified by construction work results to standardize and

facilitate communication within the construction industry. The MasterFormat system is

widely used in the construction industry by architects, engineers, estimators, and

contractors to organize detailed construction cost information.

Currently, the IRS most commonly sees the following system in cost segregation studies,

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The CSI Format consists of 16 "Divisions of the Work", which are:

• Division 1 - General Requirements

• Division 2 - Site Work

• Division 3 - Concrete

• Division 4 - Masonry

• Division 5 - Metals

• Division 6 - Wood & Plastics

• Division 7 - Thermal & Moisture

• Division 8 - Doors & Windows

• Division 9 - Finishes

• Division 10 - Specialties

• Division 11 - Equipment

• Division 12 - Furnishings

• Division 13 - Special Construction

• Division 14 - Conveying Systems

• Division 15 - Mechanical

• Division 16 - Electrical

Each CSI Division is further sub-divided into three additional parts called General,

Products, and Execution (Installation).

• General - explains the scope or the limits of work for a particular CSI Division and

makes a correlation between the technical specifications and the general and

supplementary conditions of the contract. The administrative portion for any trade

(e.g., shop drawings) would also be found in this section.

• Products - lists the materials to be used, by name and model number, and explains

the quality of materials and the basis for any substitution.

• Execution - explains the method of material installation, techniques to be used, and

workmanship quality.

In 2004, the MasterFormat expanded from 16 Divisions to 50 Divisions, reflecting

innovations in the construction industry. The 16 Division CSI MasterFormat was modified to

include many more divisions and provide greater detail for work results to accommodate

current trades and systems now included in most buildings. An example of the modification

from 2004 includes a division for communication systems separate from the electrical

division. The new CSI MasterFormat numbers and titles are intentionally structured for

anticipated growth and expansion in the future, and some are reserved for future

expansion.

The New Divisions are:

PROCUREMENT AND CONTRACTING REQUIREMENTS GROUP:

• Division 00 — Procurement and Contracting Requirements

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SPECIFICATIONS GROUP

General Requirements Subgroup

• Division 01 — General Requirements

Facility Construction Subgroup

• Division 02 — Existing Conditions (natural conditions)

• Division 03 — Concrete (footing)

• Division 04 — Masonry (concrete block/brick)

• Division 05 — Metals (beams)

• Division 06 — Wood, Plastics, and Composites (framing)

• Division 07 — Thermal and Moisture Protection (insulation water barrier)

• Division 08 — Openings (doorways)

• Division 09 — Finishes

• Division 10 — Specialties

• Division 11 — Equipment

• Division 12 — Furnishings

• Division 13 — Special Construction

• Division 14 — Conveying Equipment

• Division 15 to 19 — RESERVED FOR FUTURE EXPANSION

Facility Services Subgroup:

• Division 20 — RESERVED FOR FUTURE EXPANSION

• Division 21 — Fire Suppression

• Division 22 — Plumbing

• Division 23 — Heating Ventilating and Air Conditioning

• Division 24 — RESERVED FOR FUTURE EXPANSION

• Division 25 — Integrated Automation

• Division 26 — Electrical

• Division 27 — Communications

• Division 28 — Electronic Safety and Security

• Division 29 — RESERVED FOR FUTURE EXPANSION

Site and Infrastructure Subgroup:

• Division 30 — RESERVED FOR FUTURE EXPANSION

• Division 31 — Earthwork

• Division 32 — Exterior Improvements

• Division 33 — Utilities

• Division 34 — Transportation

• Division 35 — Waterway and Marine

• Division 36 to 39 — RESERVED FOR FUTURE EXPANSION

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Process Equipment Subgroup:

• Division 40 — Process Integration

• Division 41 — Material Processing and Handling Equipment

• Division 42 — Process Heating, Cooling, and Drying Equipment

• Division 43 — Process Gas and Liquid Handling, Purification and Storage Equipment

• Division 44 — Pollution Control Equipment

• Division 45 — Industry-Specific Manufacturing Equipment

• Division 46 — Water and Wastewater Equipment

• Division 47 — RESERVED FOR FUTURE EXPANSION

• Division 48 — Electrical Power Generation

• Division 49 — RESERVED FOR FUTURE EXPANSION

As Cost Segregation Professionals convert to this newer system, the IRS will see more

studies incorporating the 50 Divisions. No matter which system is utilized in the cost

segregation study, it is important to note that this is just one method of organizing the

abundance of information (labor and materials) needed in a construction project. The

examiner should always look at the underlying information to verify the accuracy of the cost

segregation study.

2b (ii). AIA Construction Documents

The American Institute of Architects (AIA) is a nationally recognized professional

organization of architects. AIA has developed standardized contract documents for building

design and construction that are universally accepted in the building design and

construction industry. These AIA Contract Documents are organized by the following

series:

A-Series – Owner/Contractor Agreements

B-Series – Owner/Architect Agreements

C-Series – Other Agreements

D-Series – Miscellaneous Documents

E-Series – Exhibits

F-Series – Reserved

G-Series – Contract Administration and Project Management Forms

AIA Document A201, General Conditions of the Contract for Construction

The general conditions establish the legal terms and conditions that will govern the

construction of the project and address everything involved in the project from minor items

to critical items. The general conditions include a number of provisions that determine the

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respective rights and responsibilities of the owner and contractor. AIA Document A201 is a

standardized document that provides the legal basis and description of the following

contract items:

• General Provisions

• Owner

• Contractor

• Administration of the Contract

• Subcontractors

• Construction by the Owner or by separate Contractors

• Changes in the Work

• Time

• Payments and Completion

• Protection of Persons and Property

• Insurance and Bonds

• Uncovering and Correction of Work

• Miscellaneous Provisions

• Termination and Suspension of the Contract

Document A201 provides legal definitions of the elements in the construction process, the

items that will be provided by the contractor, and details how to prepare material submittals,

shop drawings, and progress payment requests.

3. Bidding

The third stage of the construction process is bidding. Once an owner determines that a

project is feasible and that construction financing is available, the owner will solicit bids or

proposals from general contractors and/or specialty contractors. Owners generally use

trade publications and newspapers to invite contractors to bid on a construction job. A copy

of "The Notice to Contractors" will be shown in the project’s specifications, providing

contractors with the bidding procedures.

The following is the sequence of events to prepare a contract bid:

1. The contractor obtains a copy of the plans and specifications from the owner to

prepare a formal estimate of the construction cost or bid (experienced construction

personnel prepare the bids).

2. The contractor reviews the contract plans and specifications to determine how to

build the project and to consider all the limitations or conditions the owner requires for

the project.

3. The contractor solicits bids from subcontractors, estimates their direct material and

labor costs, and evaluates the ultimate profit potential of the contract. The amount of

the bid covers the estimated costs and a profit for the construction project.

4. The owner evaluates all of the submitted bids and then awards the contract.

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5. The contract document and specs contain the project start and completion dates, the

progress billing procedures, the insurance requirements, and other pertinent

information.

The preparation of a bid is the first step in the cost control system of a construction project.

The agreed-upon bid price then becomes the budget by which the actual expenditures are

measured and drawn against. The object of a cost control system is to provide the general

contractor and/or owner with information regarding actual project costs versus the

anticipated or budgeted costs. These cost comparisons become essential for internal

control purposes.

Standard cost manuals, such as the "R.S. Means Building Construction Cost Data," are

used by a general contractor to compute a bid. These guides contain a compilation of cost

data for each phase of construction. There are also construction cost data guides for both

union and non-union wage rates. If the IRS examiner needs to estimate construction costs

as part of the analysis of a study, it is important to use the proper wage rates.

Subcontractors bid jobs in much the same way that a general contractor does. A

subcontractor may also solicit bids from sub-subcontractors for specialty construction.

Working drawings and specifications provide information to allow general contractors to

estimate the project’s construction costs. Along with using their own estimators, a

contractor usually has the subcontractor’s and the material supplier’s information readily

available. If necessary, a general contractor can perform the preliminary details and/or

shop to estimate the proper costs to construct various parts of a building. The general

contractor gathers all the information from his estimators and subcontractors and then adds

in an amount for overhead and profit. This final cost estimate is used in the competitive

bidding for the construction of a project.

The cost estimate of a building or project is broken down and organized by the construction

divisions shown in the specifications. The cost estimate is further detailed by trade and by

item. The general contractor may also have a bank of information to estimate labor and

material costs. Otherwise, the contractor will rely on any of several cost estimating manuals

(e.g., R. S. Means Building Construction Cost Data (highly detailed), Marshall Valuation

Services, etc.).

While bidding is the most common method used to select a general contractor, negotiation

may also be used, especially in a situation where an owner has worked with a contractor in

the past and a relationship of trust has been established. In a negotiated situation, the profit

of the contractor is often a percentage of the total construction cost and this percentage is

agreed to with the owner.

4. Construction (Field Work)

The fourth stage of the construction process, called fieldwork, is the actual construction of

the project. Fieldwork is broken down into building permits, subcontractors, scheduling

subcontractors, shop drawings, project submissions, and change orders.

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Building Permits

Before construction can begin, the appropriate municipality must issue a building permit.

Specifications and blueprints must be provided to the municipality's building department,

along with the application for a permit. The period of time for a permit to be approved can

be lengthy, especially in the case of new construction. The general contractor or owner

may also be required to submit results of soil testing, environmental impact studies, and

any other necessary testing or studies. Sometimes, a public hearing is mandated if there is

opposition to the project. In most cases, a permit is issued within a few months. The cost of

the permit and any related studies may be the responsibility of either the owner or the

general contractor.

Construction projects must also follow the standards of the applicable building code. A

building inspector will be involved at various construction stages to verify that the project is

being constructed according to municipal code.

Subcontractors

Subcontractors range from a one-man operation to nationwide, publicly traded

corporations, or divisions of larger corporations. Subcontractors are distinguished from

general contractors by their limited scope of work, which usually involves specialized skills,

knowledge, or ability. Subcontractors, which include plumbers, electricians, framers, and

concrete workers, generally enter into contracts with the general contractor and may

provide the raw materials used in their specialty areas. The general contractor, not the

owner of the property, pays the subcontractors. Materials purchased by the subcontractors

are generally delivered directly to the job site. The subcontractors’ work may either be

completed in stages or continuously.

Scheduling of Subcontractors

The general contractor schedules the subcontractor's work so that the construction runs

smoothly and is completed on schedule. The general contractor is also responsible for

scheduling the subcontractor in such a way that one subcontractor does not hold up

another. This order on subcontractor sequencing is known as the "critical path."

The following is an example of the sequence in scheduling subcontractors for a small

project:

1. Clear the land (which may include demolition of existing structures)

2. Excavate the land (which may include digging holes and leveling)

3. Pour the foundation

4. Frame steel and/or concrete

5. Rough framing

6. Rough electrical

7. Concrete flooring

8. Roofing

9. Heating and air conditioning

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10. Ductwork for heating and air conditioning

11. Elevators and/or escalators

12. Sprinklers and other safety equipment

13. Install electrical fixtures

14. Insulate and weather strip

15. Frame windows and door sashes

16. Install tile and marble

17. Install suspended acoustical ceilings

18. Install toilets, sinks and other plumbing fixtures

19. Paint walls (inside and out)

Shop Drawings

Working drawings only include enough detail to show the general contractor the overall

layout of the building. The individual specialty trades and suppliers use working drawings to

produce shop drawings for items such as granite finishing, cabinets and countertops,

structural steel, etc. Shop drawings detail the specific building components and are usually

produced after the final design phase but before the beginning of the construction phase.

Drawings are prepared in accordance with the instructions on Document A201. The

architect/engineer will also check each shop drawing for precise measurements and for

compliance with the intended building design.

Project Submissions

Project submissions are an important part of the construction process. Each installed

building item must receive the architect’s approval to ensure that the item or product is in

conformance with technical specifications. Project submissions illustrate each item's

intended use, function, method of attachment or installation requirements, and placed-in-

service date. When the project starts, the architect and /or engineer monitors the

contractor’s progress and often approves the progress payments made to the contractors.

The architect/engineer may also make modifications to the building plans as needed.

Change Orders

Change orders are the written contract revisions that increase or decrease the total

contract price. Change order documents contain the change order number, change order

date, a description of the change, and the amount of the change order. Contractors, based

on the terms of the contract, may also issue orders.

5. Construction Payments

The fifth stage of the construction process is the construction payments stage. When a

contractor completes a prescribed amount of work, the owner pays the contractor for the

completed work, and records the payments on their books (CIP or WIP accounts).

Specifications for Payment

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The following AIA Documents are normally used in the contractor progress payment

process:

AIA G701 – Change Order

AIA G702 – Application and Certificate for Payment

AIA G703 – Continuation Sheet

The specifications for contract payments are shown in Document A201, under the “General

Conditions for Construction Contracts”, and contain AIA Forms G701 (utilized for change

orders) and G702. Form G702 requires that the contractor break down the bid into various

parts of work. The project designer (architect or engineer) critically reviews Form G702

schedule of values prepared by the contractor and either accepts or rejects them. The

close scrutiny of this form is due to the future release of funds that will be used to pay for

the progress (and ultimately the completion) of construction. This form also provides the

first basis for the construction cost control on a project. The architect and/or engineer have

a legal and fiduciary responsibility for the accuracy of the cost allocations. The architect

and the owner also want an adequate and timely distribution of funds to ensure smooth

progress payments and to ensure that there will be the necessary funds to pay for the

completion of the last portion of the project.

It is also to the contractor’s benefit that items of construction be broken into as many parts

as possible. The more individual items of work the contractor can identify and complete, the

more items of work will be entitled for billing and request of payment. Typical schedules of

values on Form G702 may be 15 to 20 pages long and may contain hundreds, if not

thousands, of individual cost items.

The contractor submits Form G702 to request payment on a regular basis. The contractor

completes Form G702 by listing the total construction cost for each item of work completed

to date. The amount previously paid for the work and the amount accomplished in the

current billing period are subtracted from the total amount to arrive at the amount of money

remaining, minus a retainage for the completion of the work.

It is extremely important for the IRS examiner to analyze the G702 and G703 documents.

These documents are prepared by a third party (which provides an element of objectivity)

and includes a detailed breakdown and analysis of the construction costs.

Change Orders

The architect/engineer may make modifications or change orders to the construction plans

as needed. Change orders should be reviewed for any agreed changes to the payment

schedule.

Unit Costs

In some contracts, there is a schedule of unit costs or prices used in the construction of the

building. CSI MasterFormat Division 01 in the 16 Division format or Division 00 in the new

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50 Division format typically provides for unit prices to be revealed in the bidding documents.

The IRS examiner should verify that there is a schedule of Unit Prices in the contract

documents and request a copy.

Owner’s Records

Most Corporate Taxpayers must keep records of their payments in a sub ledger for

construction-in-process (CIP) or work-in-process (WIP) type costs to comply with GAAP

requirements. All payments made by a company are recorded on their general ledger (GL).

The payment records are transferred and held to the appropriate sub ledger until the

project is completed. When the building project is placed in service, the taxpayer moves or

transfers the costs to their fixed asset or depreciation schedule and begins cost recovery

for the project for both book and tax purposes. The IRS examiner should request all

relevant costs in these accounts for the cost segregation project under examination.

6. Completion

The final phase of the construction process is known as the completion stage, and it

readies the building for occupancy.

Record Drawings (previously called As-Built’s)

After a facility or project is completed, the architect and contractor prepare a set of plans

known as record drawings. These drawings represent exactly how the facility was

constructed and they also incorporate all the changes to the original construction drawings.

It is very important that the IRS examiner reviews these record drawings; these drawings

represent the actual construction of the project.

Notice of Partial Completion

In some instances, the owner may desire to occupy a portion of the completed building. In

that case, local building officials conduct an inspection to determine if that portion of the

facility meets all building codes and is safe to be occupied. If approval is granted, a

"Certificate/Notice of Partial Occupancy" is issued.

Notice of Substantial Completion

Local building officials issue this notice when 95 % of the construction is complete.

Notice of Completion/Certificate of Occupancy

A "Notice of Completion" is requested by the contractor/owner when the building is 100%

complete. The project must pass a final inspection by local building officials for the "Notice

of Completion" and the "Certificate of Occupancy" to be issued. These documents are

recorded at the office of the local recorder and the property will be then appraised for

property tax purposes.

Taxpayer Places the Asset in Service – Begins Depreciation

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The costs for the project are recorded in the taxpayer’s CIP or WIP sub ledger, and held in

this suspense account until the costs can be recovered. Once the project is placed in

service, depreciation can begin. For the taxpayer’s recordation of the project, in their books

and records, depreciation begins when the costs in the CIP are transferred into a fixed

asset account or to a depreciation schedule (See CCA 20140202F). The IRS examiner

should request these records from the taxpayer.

3. Other Project Delivery Methods

While design-bid-build is probably the most common delivery method used for construction

projects today, there are other methods. The differences between the various project

delivery methods mainly stem from how the parties organize their participation and

responsibilities to complete the project. While the responsibilities of the parties may vary

based on the specific project delivery method, the contract documents that guide

construction and the contractor payment process are normally similar in all project delivery

methods. The two methods an examiner is most likely to encounter, besides design-bid-

build, are construction management and design-build.

Construction Management – This project delivery method is very similar to the design-bid-

build method, but the management and construction oversight duties ordinarily performed

by the general contractor are performed by a construction manager. The construction

manager does not perform any of the actual construction work as a general contractor

does, but only manages the construction.

Design-Build – This is a project delivery method in which the owner contracts with a single

entity to perform both the design and the construction of the project. The Design-Builder

either employs their own licensed architects and engineers to perform the design duties or

they contract these duties out to the appropriate third-parties. There are no separate

architect and contractor as in design-bid-build.

G. Information Document Requests

1. Introduction

Appropriate documentation is needed to support the conclusions in a cost segregation

study. Once an examination has revealed the use of cost segregation techniques, the

examiner needs to review the supporting documentation to determine whether an

examination is warranted and, if so, the scope of the examination.

The use of appropriate issue focused Information Document Requests (IDR’s) will facilitate

the identification of available records for review and the solicitation of records from the

taxpayer. It will also set in writing a mutually agreeable timeframe for when the information

should be provided. The sample IDR language below is intended as a suggestion for

obtaining records. One or more IDR's may need to be issued and examiners should tailor

the language to each specific case and follow the Large Business and International (LB&I)

directives. For additional information on the IDR process see the following directives and

training:

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• LB&I-04-0214-004 Updated Guidance for Examiners on Information Document

Requests Enforcement Process dated 2/28/14 incorporates and supersedes:

• LB&I-04-0613-004 Large Business and International Directive on Information

Document Requests Process dated 6/18/13

• LB&I-04-0113-009 Large Business and International Directive on Information

Document Requests Enforcement Process dated 11/4/13

2. IDR G.1 Purpose – To Identify the Participants and their Respective Roles

in the Preparation of a Cost Segregation Study/Analysis

Please provide documentation to support all changes to the cost recovery deductions

indicated on the Cost Segregation reports.

Please provide the Engagement Letter/Letter of Understanding between Consultant and

Taxpayer, Inc., that shows the extent of the Cost Segregation engagement, the steps taken

to gather information, and the way in which the work was to be reported.

Additionally, a conference is requested with a representative from Consultant to describe

the Cost Segregation process and to answer questions concerning the style and general

cost computations. It is expected that a telephone conference will be suitable, provided the

Engagement Letter/Letter of Understanding has been furnished.

3. IDR G.2 Purpose – not Identify the Specific Properties Subject to Cost

Segregation Study/Analysis

Please provide the names and locations of properties visited and inspected by Consultant

for use in its Cost Segregation analysis.

Note to examiner: By reviewing the same properties visited by Consultant, a better

understanding of the Cost Segregation Report is achieved.

4. IDR G.3 Purpose – To Locate the Source of Property Blueprints and

Drawings

Please provide access to the construction drawings and specifications used by Consultant

to perform its Cost Segregation Study. It is not necessary to duplicate the drawings. If the

construction drawings are in hard-copy format, please provide access to them in a location

where the drawings may be reviewed. If they are in an electronic format, a copy should be

provided with the information requested in 6.7.4. (all related workpapers).

5. IDR G.4 Purpose – To Obtain a Copy of the Cost Segregation Study

Please provide a copy of the complete Cost Segregation Study, to include all schedules,

spreadsheets, and attachments referred to in the Study.

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Please locate the related workpapers for the Cost Segregation Study and hold available for

review.

6. IDR G.5 Purpose – To Obtain a Copy of the Study Computations and

Formulae

The Cost Segregation Study is described as containing numerous spreadsheets and

schedules used in arriving at the summary recommendations. Please provide a machine

sensible copy of the data files used in preparing and printing the spreadsheets and

schedules.

Please include a description of the software used in preparing the spreadsheets and

schedules.

Please provide an index to the machine sensible files, (or other description of the file titles

and how the files are identified). If the machine sensible copy is a visual copy, or value only

copy, then an additional description and presentation of the mathematical formulae used to

perform the computations is also requested.

7. IDR G.6 Purpose – To Ask Specific Questions about Segregated

Properties

The blueprint review is complete. Specific questions about the study remain.

With regard to the “Quantity Take Off” schedules prepared by Consultant for the properties,

there are certain unidentified assets that would fit into more than one MACRS class,

depending upon location and use in the taxpayer’s business. Please provide a copy of the

detailed listing of the Consultant’s selected assets, showing use and location for:

• Receptacles in Kitchen

• Junction Boxes in Kitchen

• Disconnect Switches in the Kitchen

• Receptacles in Offices

• Junction Boxes in Offices

• Circuit Breakers in Offices

• Receptacles in Lab areas

• Junction Boxes in Lab areas

• Floor Drains in Kitchen

• Sinks in Kitchen

• 3” pipe in Lab areas

• 1” pipe in Lab areas

These assets were opined to have shorter lives than the building lives.

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8. IDR G.7 Purpose – Request for Specific Items and Amounts

Please provide copies of all construction contracts, addenda, purchase orders, change

orders (including the Contract Bid breakdowns) for each item listed below. Note: The

Property Unit Numbers and Descriptions were obtained from the formal Cost Segregation

Analysis.

Category Description Amount

A Exterior Façades - sec. 1245 $1,203,000

B Interior Decorations - sec 1245 3,069,000

C Interior Decor - 1245 1,458,000

D Interior Columns - 1245 180,000

E Wallpaper 1,039,000

F Signage 1,967,000

G Property Utilities 1,902,000

H Room Locking Systems 772,000

I Backup Generator 814,000

J Equipment Connects - Rooms 1,338,000

K Ceiling Decorations 390,000

L Equipment Connects - Kitchen 422,000

M Equipment Connects - Mech. Room 1,338,000

N Equipment Connects - Jacuzzi 62,000

O Kitchen Exhaust 114,000

P Equipment - Display Room 830,000

Q Sound Room - Display Room 189,000

R Millwork and Trim 2,811,000

S Interior Decorative Lighting 334,000

T Interior Dec. Lighting - Connects 861,000

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Note: Include all progress payment requests along with the architect’s or construction

manager’s certification of the percentage completion (e.g., Application and Certificate for

Payment – AIA Form G-702).

H. IRC §§ 179, 179D and Bonus Depreciation

1. Recent Law

The PATH Act of 2015, the Tax Cuts and Jobs Act (TCJA) of 2017, and the Coronavirus

Aid, Relief, and Economic Security (CARES) Act all made significant changes to IRC § 179,

MACRS, and the § 168(k) bonus depreciation provisions. For changes to § 168(k), the

PATH Act applied to property placed in service after December 31, 2015. So, it affected

tax years 2016 and 2017, and the TCJA applied to property acquired and placed in service

after September 27, 2017. The CARES Act made retroactive changes to the recovery

period of Qualified Improvement Property (QIP) from 39-years to 15-years (GDS) and from

40-years to 20-years (ADS), for property placed in service after 12/31/17. The Taxpayer

Certainty and Disaster Tax Relief Act of 2020 (TCDTRA) made the IRC §179D deduction

permanent. TCDTRA also retroactively changed the ADS recovery period from 40 to 30

years for certain residential rental property placed in service before January 1, 2018, held

by an electing real property trade or business as defined in § 163(j)(7)(B), and not

previously subject to ADS. For more information on this change, see Rev. Proc. 2021-28.

2. IRC § 179 Deduction

Taxpayers, other than estates, trusts and certain non-corporate lessors, may elect to

deduct the cost of their IRC § 179 property in the year in which it is placed in service,

subject to limitations. The aggregate amount of the cost of § 179 property that a taxpayer

can elect to deduct under § 179 is limited to a maximum dollar limit that is adjusted

annually for inflation (for tax years beginning in 2020 - $1,040,000 and 2021 - $1,050,000)

and a dollar limitation on the total cost of § 179 property placed in service during that

taxable year (Investment threshold limit) that is adjusted annually for inflation (for tax

years beginning in 2020, $2,590,000 and 2021 - $2,620,000). The dollar limit for the tax

year is reduced (but not below 0) by the amount by which the cost of § 179 property

placed in service during the tax year exceeds the Investment threshold limit for that tax

year. The total cost that a taxpayer can deduct in the tax year after applying the § 179

dollar limitation is limited to the amount of taxable income derived from a taxpayer’s active

conduct of any trade or business during the tax year. Section 179 property generally

means any tangible property that is described in section 179(d)(1) that is acquired by

purchase for use in the active conduct of the taxpayer’s trade or business. Section 179

property includes:

• Tangible property (to which IRC § 168 applies) which is § 1245 property, such as,

machinery and equipment; property contained in or attached to a building (other

than structural components), such as refrigerators, grocery store counters, office

equipment, printing presses, testing equipment, and signs; gasoline storage tanks

124 | Page

and pumps at retail service stations; and livestock, including horses, cattle, hogs,

sheep, goats, and mink and other furbearing animals.

• Depreciable portable air conditioning and heating units which are § 1245 property

placed in service in tax years beginning after 12/31/2015.

• Depreciable tangible property used predominantly to furnish lodging or in

connection with furnishing lodging and which is section 1245 property placed in

service in tax years beginning after 12/31/2017.

• Computer software (as defined in IRC § 197(e)(3)(B)) that is readily available for

purchase by the general public, is subject to a nonexclusive license, and has not

been substantially modified, and to which section 167 applies.

• Qualified real property- At the election of the taxpayer, qualified real property (as

defined in IRC § 179(e)). The definition of qualified real property has changed over

the years from qualified leasehold improvement property (QLIP), qualified retail

improvement property (QRIP) and qualified restaurant property (QRP) to, for

property placed in service in tax years beginning after December 31, 2017: (1)

qualified improvement property (QIP) described in IRC § 168(e)(6); and (2) certain

improvements to nonresidential real property that were placed in service after the

date such property was first placed in service. These improvements are: heating,

ventilation, and air conditioning property (HVAC); roofs; fire protection and alarm

systems; and security systems (IRC § 179(e)(2)).

Taxpayers claiming the IRC § 179 deduction must reduce the depreciable basis of the §

179 property by the amount of its cost that the taxpayer elected to deduct (See Treas. Reg.

§ 1.179-1(f)). This reduction is done prior to computing additional first year depreciation

under IRC § 168(k) and depreciation under IRC § 168.

IRC § 179 Qualified Real Property

Placed

In Service

Range

Qualified Real

Property 179

(QRP179)

Qualified Leasehold

Improvement

Property (QLIP)

Qualified Restaurant

Property (QRP)

Qualified Retail

Improvement

Property

(QRIP)

Qualified

Improvement

Property

(QIP)

Tax years

beginning after

2009 and before

2018

Yes*

Yes

Tax years

beginning after

2017

Yes**

Yes

* QRP179 was defined as QLIP, QRP, and QRIP placed in service in tax years beginning after 2009 and before 2018

125 | Page

** QRP179 placed in service in tax years beginning after December 31, 2017, is defined under § 179(e) as QIP

under § 168(e)(6) and also the following improvements to nonresidential real property placed in service after the

date such property was first placed in service: heating, ventilating, & air conditioning (HVAC); roofs; fire

protection and alarm systems; and security systems.

Additional 179 Property

Placed

In Service Range

Tangible

Property

(to which §

168

applies)

That Is

1245

Property

1245 Property Used to

Furnish Lodging

1245 Portable Air

Conditioning and

Heating Units

Tax years

beginning after

2009 and before

2016

Yes

Tax years

beginning after

2015 and before

2018 Yes No Yes

Tax years

beginning after

2017 Yes Yes Yes

3. IRC § 179D Deduction

Building Owners and Lessors may deduct the cost of Energy Efficient Commercial Building

Property (EECBP) installed in their buildings up to a maximum $1.80/sf of the building.

Similar to the IRC § 179 deduction, taxpayers claiming the IRC § 179D deduction must

reduce the depreciable basis of the EECBP by the amount of its cost that the taxpayer

elected to deduct (See IRC § 179D(e)). This reduction is done prior to computing

additional first year depreciation under IRC § 168(k) and depreciation under IRC § 168.

4. Bonus Depreciation – In General

Cost segregation studies are used by taxpayers most commonly to identify portions of real

property that are separate tangible personal properties subject to shorter depreciable

recovery periods. Some of these properties may also qualify for additional first-year

126 | Page

depreciation, commonly referred to as “bonus” depreciation. Bonus depreciation allows

taxpayers to deduct a specified percentage (e.g., 30, 50, or 100 percent) of depreciation in

the year the qualifying property is placed in service. The adjusted basis of the qualifying

property is reduced by the allowable amount of bonus depreciation before the remaining

depreciation deductions are computed for the placed-in-service year and subsequent

years.

Eligible Property - To qualify for 20, 30, 40, 50, 60, 80, or 100 percent bonus depreciation,

the original use of the property must begin with the taxpayer (except for certain used

property acquired and placed in service after September 27, 2017) and the property must

be: 1) MACRS property with a recovery period of 20 years or less, 2) computer software as

defined in, and depreciated under, § 167(f)(1), 3) water utility property as defined in §

168(e)(5), 4) qualified leasehold improvement property placed in service prior to 1/1/2016,

or qualified improvement property placed in service after 12/31/2015 and before1/1/2018,

5) a qualified film or television production after 9/27/2017, 6) a qualified live theatrical

production after 9/27/2017, or 7) a specified plant (if elected). Certain acquisition

requirements and placed in service dates must also be met to qualify for 20, 30, 40, 50, 60,

80, or 100 percent bonus depreciation, and are discussed in more detail below.

Original Use of the Property - The term “original use” means the first use to which the

property itself is put, whether or not that use corresponds to the use of the property by the

taxpayer. The original use of the property by the taxpayer begins on the date the taxpayer

uses the property primarily in its trade or business or for the production of income.

Generally, this would be the date the property is placed in service. However, if a taxpayer

initially acquires new tangible personal property and holds it as inventory primarily for sale

to customers, but subsequently withdraws the property from inventory and uses it in their

trade or business, the taxpayer is considered the original user of that property. A cost

segregation study may also identify certain costs incurred by a taxpayer to acquire or

construct reconditioned or rebuilt tangible personal property that is used in the real

property. The cost to acquire or construct the reconditioned or rebuilt tangible personal

property does not satisfy the original use requirement. Determining if tangible personal

property is reconditioned or rebuilt is a question of fact, but property that contains used

parts is not treated as reconditioned or rebuilt if the cost of the used parts is no more than

20 percent of the total cost of the property, whether the property is acquired or constructed

by the taxpayer.

Used Property - For qualified property acquired and placed in service after September 27,

2017, eligible property is expanded to include certain used depreciable property. Used

property is eligible for the bonus depreciation deduction if it meets the following

requirements: (1) the property was not used (that is, no depreciable interest was held in the

property) by the taxpayer or a predecessor at any time prior to the acquisition. Pursuant to

Treas. Reg. § 1.168(k)-2(b)(3)(iii)(B)(1), this is determined by taking into account only the

five calendar years immediately before the current calendar year in which the property is

placed in service, without taking into account the applicable convention; (2) the acquisition

of the property meets the related party and carryover basis requirements of IRC §

179(d)(2)(A), (B), and (C) and Treas. Reg. § 1.179-4(c)(1)(ii), (iii), and (iv), or (c)(2); and (3)

the acquisition of the property meets the cost requirements of IRC § 179(d)(3) and Treas.

127 | Page

Reg. § 1.179-4(d). However, any QIP previously placed in service by the seller of a

nonresidential building is not eligible used property to the taxpayer that purchases the

building because the improvement is not made by the taxpayer that purchased the building.

IRC § 168(e)(6) and Treas. Reg. § 1.168(b)-1(a)(5)(i)(A).

Qualified Leasehold Improvement Property - A cost segregation study may also identify

the cost of leasehold improvement property placed in service before 2018. Qualified

leasehold improvement property is any improvement to the interior portion of a building

(CCA 201310028) that is nonresidential real property if the following three conditions are

satisfied:

1. It must be made under a lease by the lessee, sub-lessee, or lessor of that portion;

2. The portion must be set for occupancy by the lessee or sub-lessee; and

3. The improvement must be placed in service more than three years after the date the

building was first placed in service.

Qualified leasehold improvement property does not include any improvement for which the

expenditure is attributable to the enlargement of the building, any elevator or escalator, any

structural component benefiting a common area, or the internal structural framework of the

building.

Qualified leasehold improvement property (QLIP) is eligible for the bonus depreciation per

statute, see 168(k)(3) prior to 2016. However, for the purposes of the bonus depreciation,

for property placed in service after December 31, 2015, QLIP was replaced by qualified

improvement property. QLIP is eliminated for property placed in service after 12/31/2017.

Qualified Retail Improvement Property and Qualified Restaurant Property

Qualified retail improvement property (QRIP) and qualified restaurant property (QRP) have

a recovery period of 15 years, but they are generally ineligible for bonus depreciation

unless the property also meets the definition of QLIP. Note: QRP acquired and placed in

service in 2008 was eligible for bonus depreciation.

For property placed in service after 2008, QRP is defined in IRC § 168(e)(7) (in effect

before the enactment of TCJA), as any IRC § 1250 property which is a building or an

improvement to a building, if more than 50 percent of the building’s square footage is

devoted to the preparation of, and seating for on-premises consumption of, prepared

meals. For property placed in service after December 31, 2017, QRP is no longer defined.

For property placed in service after December 31, 2017, QRIP is no longer defined. For

property placed in service after 2008, QRIP is defined in IRC § 168(e)(8) (in effect before

the enactment of TCJA) as any improvement to an interior portion of a building which is

nonresidential real property if –

1. Such portion is open to the general public and is used in the retail trade or business

of selling tangible personal property to the general public, and

2. Such improvement is placed in service more than three years after the building was

first placed in service by any person. IRC § 168(e)(8)(A)(ii); Treas. Reg. § 1.168(k)-

128 | Page

1(c)).

Like qualified leasehold improvement property, QRIP does not include the enlargement of

the building, any elevator or escalator, structural components benefiting a common area, or

the internal structural framework of the building.

QRIP and QRP are eliminated for property placed in service after 12/31/2017.

Qualified Improvement Property (QIP)

Property qualifying for the bonus depreciation as defined in IRC § 168(k)(2)(A) includes

“qualified improvement property” (QIP) placed in service after December 31, 2015 and

before January 1, 2018. It was created to allow certain improvements to the interior of an

existing building to be eligible for the bonus depreciation regardless of the presence of a

lease for that property. QIP was defined in IRC § 168(k)(3) as any improvement to an

interior portion of a building which is nonresidential real property (39 year recovery period)

if such improvement is placed in service after the date such building was first placed in

service. Similar to qualified leasehold improvement property, QIP does not include any

improvement for which the expenditure is attributable to the enlargement of the building,

any elevator or escalator, or the internal structural framework of the building.

NOTE: This provision allowed bonus depreciation for QIP without regard to whether the

improvements are property subject to a lease and removes the requirement that the

improvement must be placed in service more than three years after the date the building

was first placed in service. (PATH Act P.L. 114-113)

The TCJA (P.L. 115-97) eliminated QIP placed in service after 12/31/2017 from IRC §

168(k) as eligible property for bonus depreciation. The TCJA added the definition of QIP to

the Classification of Property IRC § 168(e)(6), yet no property class was specified. As

such, QIP placed in service after 12/31/2017 was classified by default as nonresidential

real property with a 39-year recovery period under GDS.

The CARES Act (P.L. 116-136) provided a technical correction for QIP. The recovery

period for QIP placed in service after December 31, 2017, was reduced from 39 years to 15

years for GDS by the addition of IRC § 168(e)(3)(E)(vii) thereby making it eligible for bonus

depreciation. The ADS recovery period for QIP placed in service after December 31, 2017

was also reduced from 40 years to 20 years. The definition of QIP in IRC § 168(e)(6) was

also amended to provide that the improvements must be "made by the taxpayer." These

changes were made retroactive to January 1, 2018, as if they were included in the TCJA.

As a result, taxpayers that depreciated QIP that was placed in service after December 31,

2017 using a GDS 39-year recovery period or an ADS 40-year recovery period are on an

impermissible method of accounting. Revenue Procedure 2020-25 provides guidance

allowing eligible taxpayers to change their method of depreciating QIP that was placed in

service after December 31, 2017, in the taxable years ending in 2018, 2019, or 2020.

129 | Page

5. Acquisition Requirements and Placed in Service Dates

Note, as of the date of this writing, bonus depreciation is not available for property placed in

service after December 31, 2026 (December 31, 2027 for long production period property

and specified aircraft).

Pre-2005 30% Bonus Depreciation – Acquisition Requirements and Placed in Service

Dates

To qualify for 30% bonus depreciation as in effect before the enactment of the Economic

Stimulus Act of 2008 (Pre-2005 30%), the property must be placed in service by the

taxpayer after September 10, 2001 and before January 1, 2005 (note that for 20%, 30%,

40%, 50%, 60%, 80%, and 100% bonus depreciation, special placed in service rules apply

to long production period property and specified aircraft).

One of two alternative acquisition requirements must also be met:

1. The first requirement is met if the property is acquired by the taxpayer after

September 10, 2001, and before January 1, 2005, but only if no written binding

contract for the acquisition was in effect before September 11, 2001; or

2. The second requirement is met if the property is acquired by the taxpayer pursuant

to a written binding contract entered into after September 10, 2001, and before

January 1, 2005.

50% Bonus Depreciation – Acquisition Requirements and Placed in Service Dates

50% bonus depreciation is allowable for qualifying property placed in service during three

different time periods:

1. Property placed in service after May 5, 2003 and before January 1, 2005;

2. Property placed in service after December 31, 2007 and before September 9, 2010;

and

3. Property placed in service after December 31, 2011 and before January 1, 2018.

NOTE: Property placed in service after December 31, 2004 and before January 1, 2008

generally is not eligible for bonus depreciation.

For property placed in service after May 5, 2003 and before January 1, 2005, one of two

alternative acquisition requirements must also be met:

1. The first requirement is met if the property is acquired by the taxpayer after May 5,

2003, and before January 1, 2005, but only if no written binding contract for the

acquisition was in effect before May 6, 2003; or

2. The second requirement is met if the property is acquired by the taxpayer pursuant

to a written binding contract entered into after May 5, 2003, and before January 1,

2005.

130 | Page

For property placed in service after December 31, 2007 and before September 9, 2010,

one of two alternative acquisition requirements must also be met:

1. The first requirement is met if the property is acquired by the taxpayer after

December 31, 2007, and before September 9, 2010, but only if no written binding

contract for the acquisition was in effect before January 1, 2008; or

2. The second requirement is met if the property is acquired by the taxpayer pursuant

to a written binding contract entered into after December 31, 2007, and before

September 9, 2010.

For property placed in service after December 31, 2011 (December 31, 2012, in the case of

long production period property and specified aircraft) and before January 1, 2016, one of

two alternative acquisition requirements must also be met:

1. The first requirement is met if the property is acquired by the taxpayer after

December 31, 2007, and before January 1, 2016, but only if no written binding

contract for the acquisition was in effect before January 1, 2008; or

2. The second requirement is met if the property is acquired by the taxpayer pursuant

to a written binding contract entered into after December 31, 2007, and before

January 1, 2016.

NOTE: Bonus depreciation is increased from 50% to 100% for qualified property acquired

after September 27, 2017, and placed in service after September 27, 2017, and before

January 1, 2023 (January 1, 2024, in the case of long production period property and

specified aircraft).

100% Bonus Depreciation (after 9/8/2010 and before 1/1/2012) – Acquisition

Requirements and Placed in Service Dates

As part of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act

of 2010, Congress added § 168(k)(5). As a result of this Act, certain 50% qualified property

that is acquired by the taxpayer after September 8, 2010, and before January 1, 2012

(January 1, 2013, in the case of long production period property and specified aircraft), and

that is placed in service by the taxpayer after September 8, 2010, and before January 1,

2012 (January 1, 2013, in the case of long production period property and specified aircraft)

is eligible for 100% bonus depreciation.

To qualify for 100% bonus depreciation, the property must meet one of the following two

alternative acquisition requirements:

1. The first requirement is met if the property is acquired by the taxpayer after

September 8, 2010 and before January 1, 2012 (January 1, 2013, in the case of long

production period property and specified aircraft); or

2. The second requirement is met if the property is acquired by the taxpayer pursuant

to a written binding contract entered into after September 8, 2010, and before

January 1, 2012.

131 | Page

Section 4.02 of Rev. Proc. 2011-26, 2011-16 I.R.B. 664, provides a limited exception to the

above rule, which allows taxpayers to elect to treat all qualified property of any particular

class of property, acquired during their tax year that includes September 9, 2010, as

subject to the 50% bonus depreciation rather than the 100% bonus depreciation allowed for

property acquired after September 8, 2010, without regard to whether the property was

acquired before or after September 8, 2010.

6. Bonus Depreciation Rates After 9/27/2017

Portion of Basis of Qualified

Property Acquired before Sept.

Placed in Service Year

Bonus Depreciation

Percentage -

Qualified Property in

General/Specified Plants

Bonus Depreciation

Percentage -

Longer Production

Period Property and

Certain Aircraft

Sept. 28, 2017 − Dec. 31,

2017

50 percent

2018

40 percent

50 percent

2019

30 percent

40 percent

2020

None

30 percent

2021 and thereafter None None

Portion of Basis of Qualified

Property Acquired after Sept

Placed in service Year

Bonus Depreciation

Percentage -

Qualified Property in

General/Specified Plants

Bonus Depreciation

Percentage -

Longer Production

Period Property and

Certain Aircraft

Sept. 28, 2017 − Dec. 31, 2022

100 percent

2023

80 percent

100 percent

2024 60 percent 80 percent

2025 40 percent 60 percent

2026 20 percent 40 percent

2027 None

20 percent

2028 and thereafter

None

132 | Page

7. Acquisition Requirement – In General

The bonus depreciation regulations provide special rules for determining the timing of a

taxpayer's acquisition of qualifying property. One set of rules addresses acquired property

and the other set deals with self-constructed property. Both sets of rules can apply in the

context of a cost segregation study.

Acquisition Requirement - Acquired Property

As discussed above, a cost segregation study may identify certain acquired tangible

property that potentially qualifies for bonus depreciation. This can include tangible personal

property that is acquired by the taxpayer and used in the construction by the taxpayer (or a

third party under contract with the taxpayer) of new real property, or the expansion,

refreshment, or restoration of the taxpayer’s existing real property. Provided it is otherwise

qualifying property (e.g., MACRS property having a recovery period of 20 years or less,

etc.), tangible personal property that is acquired under a written binding contract qualifies

for bonus depreciation (i) if the placed in service dates and either of the two alternative

acquisition requirements are met for the pre-2005 30%, pre-2016 50%, or 9/9/2010 -

12/31/2011 100% bonus depreciation, respectively, or (ii) if the placed in service dates are

met for the post-2015 30%, 40% and 50% bonus depreciation, respectively, and, if

applicable, the acquisition requirements are met for the post-2015 30% and 40% bonus

depreciation for long production period property and specified aircraft.

The acquisition date requirement for 100% bonus depreciation is met if the property is

acquired by the taxpayer after September 27, 2017, or is acquired by the taxpayer pursuant

to a written binding contract entered into by the taxpayer after September 27, 2017. See

Treas. Reg. § 1.168(k)-2(b)(5)(ii)(A).

Acquisition Requirement - Self-Constructed Property

Similarly, a cost segregation study may identify certain self-constructed tangible personal

property that potentially qualifies for bonus depreciation. This can include tangible personal

property that is manufactured, constructed, or produced by the taxpayer and used in the

construction by the taxpayer (or a third party under contract with the taxpayer) of new real

property, or in the expansion, refreshment, or restoration of the taxpayer’s existing real

property used in its trade or business or for the production of income.

If a taxpayer manufactures, constructs, or produces property for use in its trade or business

or for the production of income, the acquisition requirement is satisfied if the taxpayer

begins manufacturing, constructing, or producing the property during the following dates:

1. After September 10, 2001 and before January 1, 2005 for pre-2005 30% property;

2. After May 5, 2003 and before January 1, 2005 for 50% property under § 168(k)(4) as

in effect before the enactment of the Economic Stimulus Act of 2008;

3. After December 31, 2007 and before September 9, 2010, or after December 31,

2011 and before January 1, 2016 for 50% property;

4. After September 8, 2010 and before January 1, 2012 for 100% property; and

5. For qualified property placed in service after December 31, 2015, there is no date-

133 | Page

sensitive acquisition requirement, except that certain property having longer

production periods must be acquired by the taxpayer before January 1, 2019, or

January 1, 2020, as applicable depending on the phase down percentage.

6. After September 27, 2017 for 20%, 40%, 60%, 80%, or 100% property

Property that is manufactured, constructed, or produced for the taxpayer by another person

under a written binding contract that is entered into before the manufacture, construction, or

production of the property for use by the taxpayer in its trade or business or for its

production of income is considered to be manufactured, constructed, or produced by the

taxpayer

Treas. Reg. § 1.168(k)-1(b)(4)(iii)(B)(1) provides that the manufacture, construction, or

production of property begins when physical work of a significant nature begins. Physical

work does not include preliminary activities such as planning or designing, securing

financing, exploring, or researching. The determination of when physical work of a

significant nature begins depends on the facts and circumstances. Alternatively, the

taxpayer may choose to determine when physical work of a significant nature begins in

accordance with the safe harbor rule provided in Treas. Reg. § 1.168(k)-1(b)(4)(iii)(B)(2).

Under this safe harbor rule, physical work of a significant nature does not begin before

more than 10 percent of the total cost of the property (excluding the cost of any land and

preliminary activities such as planning or designing, securing financing, exploring, or

researching) is incurred by an accrual basis taxpayer or paid by a cash basis taxpayer.

When property is manufactured, constructed, or produced for the taxpayer by another

person, this safe harbor rule must be satisfied by the taxpayer. A taxpayer chooses to

apply the safe harbor rule by filing an income tax return consistent with the safe harbor rule

for the placed-in-service year of the property that determines when physical work of a

significant nature begins.

See also Treas. Reg. § 1.168(k)-2(b)(5)(iv)(B) for property acquired after September 27,

2017.

Components of Larger Self-Constructed Properties - General Rules

• If a written binding contract is entered into to acquire a component of a larger self-

constructed property before the relevant acquisition date (for the 30%, 40%, 50%, or

100% property respectively, as described above), or the manufacture, construction,

or production of a self-constructed component begins before the relevant acquisition

date, neither the acquired or self-constructed component qualifies for bonus

depreciation, even though the larger self-constructed property may qualify. See

Example 6 of Treas. Reg. § 1.168(k)-1(b)(4)(v).

• If the manufacture, construction, or production of a larger self-constructed property

begins before the relevant acquisition date, neither the larger self-constructed

property nor any of the acquired or self-constructed components are eligible to be

treated as qualified property for bonus depreciation purposes, regardless of when

the component is acquired or when construction begins on the component. See

Example 7 of Treas. Reg. § 1.168(k)-1(b)(4)(v).

• If a binding contract to acquire a component is entered into after the relevant

134 | Page

acquisition date, or the manufacture, construction, or production of a self-

constructed component begins after the relevant acquisition date, but the

manufacture, construction, or production of the larger self-constructed property does

not begin before the close of the relevant acquisition period, the component itself

would qualify for bonus depreciation under the acquisition rules even though the

larger self-constructed property does not. See Example 13 of Treas. Reg. §

1.168(k)-1(b)(4)(v).

See also Treas. Reg. § 1.168(k)-2(b)(5)(iv)(C) for property acquired after September 27,

2017.

Components of Larger Self-Constructed Properties – Exception to the Acquisition

Date Requirement

A taxpayer may elect to treat one or more components acquired or self-constructed after

September 27, 2017, of certain larger self-constructed property as being eligible for the

100% bonus depreciation under the TCJA. The larger self-constructed property must be

property for which the manufacture, construction, or production began before September

28, 2017, property described in Treas. Reg. § 1.168(k)-2(b)(2)(i)(A), (B), (C), or (D) but the

requirement that the property has to be acquired after September 27, 2017, is disregarded,

and property that meets the requirements in Treas. Reg. § 1.168(k)-2(b), determined

without regard to the acquisition date requirement in Treas. Reg. § 1.168(k)-2(b)(5).

However, the election is not available for components of larger self-constructed property if

the taxpayer elected out of bonus depreciation for the class of property in which the larger

self-constructed property is included, or if such property is not eligible for any bonus

depreciation under section 168(k); for example, section 168(k)(9) excludes property used

by rate-regulated utilities and firms (primarily automobile dealerships) with “floor plan

financing indebtedness” as defined under section 163(j) and placed in service by the

taxpayer in any tax year beginning after December 31, 2017. Treas. Reg. § 1.168(k)-2(c).

If a taxpayer constructs a building that is residential rental property or nonresidential real

property under IRC §168(e)(2), or an improvement to such property, all property

constructed as part of that property and that is described in Treas. Reg. §1.168(k)-

2(b)(2)(i)(A), (B), (C), or (D) is taken together as the larger self-constructed property for

purposes of the component election. To be eligible, the construction of all such property of

the building must begin before September 28, 2017, and any eligible component, as

determined under Treas. Reg. § 1.168(k)-2(c)(3) of such property is eligible for the

component election.

Components of Larger Self-Constructed Properties – Special Rule for 100% Bonus

Property (after 9/8/2010 and before 1/1/2012)

There are two limited exceptions to the general rules above with respect to 100% bonus

depreciation for qualified property that is acquired by the taxpayer after September 8, 2010,

and before January 1, 2012 (January 1, 2013, in the case of long production period

property and specified aircraft), and that is placed in service by the taxpayer after

September 8, 2010, and before January 1, 2012 (January 1, 2013, in the case of long

production period property and specified aircraft):

135 | Page

• First, the otherwise qualifying components of a larger self-constructed property are

not required to be acquired by the taxpayer under a written binding contract pursuant

to section 3.02(2)(a) of Rev. Proc. 2011-26, 2011-16 I.R.B. 664; and

• Second, in contrast to the general rule that denies qualified property treatment to

both the components and the larger self-constructed property, where the larger self-

constructed property does not meet the relevant acquisition date or placed in service

date requirements, taxpayers may elect to treat any otherwise qualifying acquired or

self-constructed components of a non-qualifying larger self-constructed property as

eligible for the 100% first-year depreciation deduction. Under this election, the

component must be qualified property and must be acquired or self-constructed by

the taxpayer after September 8, 2010, and before January 1, 2012 (before January

1, 2013, in the case of long production period property and specified aircraft).

Section 3.02(2)(b) of Rev. Proc. 2011-26, 2011-16 I.R.B. 664.

Section 3.02(2)(b) of Rev. Proc. 2011-26, 2011-16 I.R.B. 664, also provides the applicable

election procedures. The election must be made by the due date (including extensions) of

the federal tax return for the taxpayer's taxable year in which the larger self-constructed

property is placed in service by the taxpayer. The election is made by attaching a

statement to that return indicating that the taxpayer is making the election provided in

Section 3.02(2)(b) of Rev. Proc. 2011-26. The attached statement must also indicate

whether the taxpayer is making the election for all, or only a portion of, the components

eligible under the rule. Finally, relief is available for taxpayers who have already filed their

federal tax returns (on or before April 18, 2011) for the taxable year in which the larger self-

constructed property was placed in service. Therefore, taxpayers receive an automatic six

month extension from the due date of its return (excluding extensions) to make the election

to treat the qualifying components of non-qualifying larger self-constructed property as

property eligible for the 100% bonus depreciation allowance.

8. Chief Counsel Guidance on the Application of Bonus Depreciation

Regulations to a Cost Segregation Study – FAA 20140202F

In a building construction project, the building (including its structural components) is not

eligible for bonus depreciation because buildings generally have a MACRS recovery period

of greater than 20 years. However, the § 1245 properties identified in a cost segregation

study generally meet the MACRS recovery period requirement (20 years or less), but each

§ 1245 property must also meet the other bonus requirements to determine its eligibility for

bonus depreciation (including the original use, acquisition, and placed in service

requirements).

In Field Attorney Advice (FAA) 20140202F (1/10/2014), the IRS concluded that the

taxpayer is required to separately identify the properties associated with a building

construction project to determine which assets constitute “qualified property.” Each

property is to be analyzed under the rules of § 168(k) to determine its eligibility for bonus

depreciation. The taxpayer has the burden of proof to show which properties are subject to

bonus depreciation. This FAA states that the first step in determining whether a property is

eligible for bonus depreciation is to determine whether it is “qualified property.” As

discussed above, the § 168(k) and regulations thereunder define qualified property for

136 | Page

bonus depreciation purposes. Significantly, the plain language of § 168(k)(2)(A) makes it

clear that eligibility for bonus depreciation in the context of components of real property is

determined with reference to factors related to each property at issue rather than with

reference to the project at issue. This means a taxpayer cannot argue that a property

qualifies for bonus depreciation simply because the "project" to which said property relates

qualifies (based on contract date, acquisition date and placed in service date of the

“project”). Rather, a taxpayer is required to separately identify the properties associated

with a project to determine which assets constitute “qualified property.” Taxpayers may do

this by performing a cost segregation study, which properly identifies separate § 1245

property constructed in conjunction with § 1250 property. Only after the properties are

segregated can the individual properties be considered for bonus depreciation eligibility.

The taxpayer in the FAA acquired a number of properties based on the terms of a building

construction contract with a third-party contractor. As discussed above, property that is

constructed for the taxpayer by another person under a written binding contract that is

entered into before the construction of the property begins is considered to be self-

constructed by the taxpayer. The taxpayer accounted for its entitlement to bonus

depreciation based on a cost segregation study. The cost segregation study identified a

number of separately identifiable properties including sidewalks, paving, and landscaping.

These properties have a MACRS recovery period of less than 20 years so they, if new,

would be qualified property and eligible for bonus depreciation as long as they meet the

other requirements of the regulations. The “building” also has other separately identifiable

properties. An example is "decorative lighting" which includes the fixtures, lamps, and

electrical wiring to the lighting as well as the direct cost of the installation of the lighting and

the indirect cost of the design. All of these costs together would be included in the cost

basis of the "decorative lighting", which would be qualified properties (as long as the

lighting is new) because their recovery period would be 20 years or less, depending on the

Asset Class of Rev. Proc. 87-56 applicable to the taxpayer’s business activity in which the

decorative lighting is primarily used.

After performing the cost segregation study and identifying each property, the next step is

to determine whether the property meets the other requirements of the bonus depreciation

regulations, including the acquisition requirement. As discussed above, self-constructed

property is acquired when construction begins on that property. The determination of when

construction begins generally depends on the facts and circumstances, but a taxpayer may

choose to determine when construction begins in accordance with the safe harbor rule

provided in the regulations. Under this safe harbor rule, construction does not begin before

more than 10 percent of the total cost of the property (excluding the cost of any land and

preliminary activities such as planning or designing, securing financing, exploring, or

researching) is incurred by an accrual basis taxpayer or paid by a cash basis taxpayer.

When property is manufactured, constructed or produced for the taxpayer by another

person, as in the present case, this safe harbor rule must be satisfied by the taxpayer.

The taxpayer in the FAA chose to apply the 10% safe harbor rule i to determine when

construction began on the properties identified in its cost segregation study. Because the

taxpayer used the accrual method of accounting for the acquisition of property pursuant to

§ 461, the taxpayer needed to determine when 10% of the cost of each property was

137 | Page

incurred. Generally, a liability is incurred for the acquisition of property under the

regulations when all events have occurred fixing the liability and economic performance

has occurred. In the case of property acquired, economic performance occurs when the

property is delivered or accepted, or when title to the property passes to the taxpayer. In

this case, the taxpayer’s liability for each qualified property was incurred when the taxpayer

accepted the property after the third-party contractor submitted a pay application. Pay

applications were used as the formal certification from the third-party contractor which

showed the total contract amount, the amount of the construction completed and a

completion figure. As each request for a progress payment was made by the contractor,

the taxpayer reviewed the amount, ascertained that the work had been completed and met

the standards set forth in the contracts, accepted the work, and soon afterwards, released

the progress payment as provided under the contract. At the point when taxpayer accepted

the work, the all events test and the economic performance test is met. With each

acceptance, the taxpayer incurred costs for that property.

However, the FAA holds that the taxpayer did not meet its burden of proof that the 10%

safe harbor was met, and as a result, the taxpayer was not entitled to bonus depreciation

on any of the qualified properties identified in the cost segregation study. Neither the pay

applications nor the cost segregation study provided by the taxpayer clearly indicated when

the costs of any of the separately identifiable properties were incurred. Specifically, as the

pay applications were not broken down to the individual properties, it was not possible to

determine when the total costs of separate properties, such as the landscaping, business

signage, or decorative items, were incurred. The burden is on the taxpayer to prove which

separately identifiable property, if any, was acquired under the safe harbor rules after

December 31, 2007.

9. Method of Accounting Issues Related to Bonus Depreciation

Unless the taxpayer elects out of bonus depreciation, they are required to deduct the 20%,

30%, 40%, 50%, 60%, 80%, or 100% bonus depreciation on qualified property depending

on the year the property is placed in service. Accordingly, the adjusted basis of the

qualified property must be reduced by the amount of allowable bonus depreciation before

computing the depreciation deduction for that property under § 167(f)(1) or § 168, as

applicable, for the placed-in-service year and for all subsequent taxable years. A taxpayer

that fails to make the proper election not to deduct bonus depreciation and doesn’t deduct

bonus depreciation on its filed return is using an impermissible method of accounting.

Cost segregation studies performed contemporaneously with the taxable year that qualified

property is placed in service should allow enough time before the tax return for that year is

filed to determine the amount of bonus depreciation and depreciation allowable on that

property. On the other hand, when a cost segregation study is performed after the tax

return is filed for the year the qualified property is placed in service, the taxpayer probably

did not claim bonus depreciation on that property, and as a consequence is using an

impermissible method of accounting. Generally, taxpayers can file an amended tax return

for the property's placed-in-service year to claim the bonus depreciation and adjust the

depreciation allowable on the qualified property, provided that the amended tax return is

filed before the taxpayer files its tax return for the first taxable year succeeding the placed-

138 | Page

in-service year. However, if the first taxable year succeeding the placed-in-service year is

already filed before the cost segregation study is performed and the qualified property is

identified, the taxpayer has adopted an impermissible method of accounting and must

change from an impermissible method to a permissible method by filing a Form 3115. If

this occurs, please contact the Deductible and Capital Expenditure (DCE) or the Method of

Accounting and Timing (MAT) Practice Networks for assistance. See the following Revenue

Procedures for additional guidance:

1. Rev. Proc. 2008-52 applies to tax years ending on or after December 31, 2007 and

before April 30, 2010.Appendix Section 6.01 allows the taxpayer to file an amended

return for the property's placed-in-service year provided that the amended return is

filed before the taxpayer files its tax return for the first taxable year succeeding the

placed-in-service year. Alternatively, the taxpayer can change from an impermissible

method of accounting to a permissible method by filing a Form 3115 for the first

taxable year succeeding the placed-in-service year.

2. Rev. Proc. 2011-14, Appendix Section 6.01, provides similar rules for a year of

change ending on or after April 30, 2010.

3. The following Revenue Procedures contain the List of Automatic Changes and

provide similar rules in Section 6.01:

Revenue Procedure

Year of change ending on or after;

2015-14

May 31, 2014

2016-29

September 30, 2015

2017-30

August 31, 2016

2018-31

September 30, 2017

2019-43

November 8, 2019

2022-14

January 31, 2022

4. Rev. Proc. 2011-26 provides a special rule for a taxpayer that did not claim the 50%

additional first year depreciation for some or all of the qualified property placed in

service by the taxpayer after December 31, 2009, on its federal tax return for its

taxable year beginning in 2009 and ending in 2010 (2009 taxable year), or its taxable

year of less than 12 months beginning and ending in 2010 (2010 short taxable year).

If Rev. Proc. 2011-26 applies, the taxpayer can claim the additional first year

depreciation for that property by filing either:

• An amended federal tax return for the 2009 taxable year or the 2010 short taxable

year, as applicable, before the taxpayer files its federal tax return for the first

taxable year succeeding the 2009 taxable year or the 2010 short taxable year, or

• A Form 3115 with the taxpayer's timely filed federal tax return for the first or second

taxable year succeeding the 2009 taxable year or the 2010 short taxable year, as

applicable, provided the taxpayer owns the property as of the first day of the year

of change.

Under Rev. Proc. 2011-26, taxpayers who do not retroactively elect bonus depreciation by

claiming the 50% bonus depreciation deduction on their 2009 or 2010 short taxable year, or

by filing an amended return or a Form 3115 as described above, are deemed to have

elected to not deduct 50% bonus depreciation for a class of qualified property. Further, if a

139 | Page

taxpayer is deemed to have elected not to apply the 50% bonus depreciation retroactively,

the deemed election out applies to both 2009 qualified property and 2010 qualified property

of the same class, including property in the same class acquired by the taxpayer after

September 8, 2010 that would have qualified for 100% bonus depreciation.

10. Election Out of Bonus Depreciation

In general, taxpayers may elect out of bonus depreciation for any qualifying property placed

in service during the taxable year. The election applies to all property of the same property

class that is placed in service by the taxpayer in the same year. For bonus depreciation

purposes, eligible property is in one of the classes described in § 168(k)(2)(A): MACRS

property with a recovery period of 20 years or less, computer software defined in, and

depreciated under, § 167(f)(1), water utility property as defined in § 168(e)(5), qualified

leasehold improvement property placed in service before 1/1/2016, or qualified

improvement property placed in service after 12/31/2015 and before 1/1/2018. Pursuant to

Treas. Reg. § 1.168(k)-1(e)(2) and Treas. Reg. § 1.168(k)-2(f)(1)(ii), the class “MACRS

property with a recovery period of 20 years or less” is further broken down to each class of

property described in § 168(e) (e.g., 5-year property). The election may be revoked only

with the consent of the Commissioner, obtained by requesting a private letter ruling.

However, Treas. Reg. § 301.9100-2(b) provides an automatic extension of 6 months from

the due date if the taxpayer timely filed its return for the placed-in-service year for the class

of property during which the taxpayer may file an amended tax return to revoke the election

out of bonus depreciation for that class of property.

For qualified property placed in service after September 27, 2017, or December 31, 2017 in

the case of qualified improvement property, eligible taxpayers may revoke an election out

of bonus depreciation for a limited period of time, by filing an amended return or Form

3115. See Revenue Procedure 2020-25 and Revenue Procedure 2020-50.

If the election to forego the bonus depreciation deduction is made, all property in the same

class of property and placed in service in the same taxable year is deemed to be non-

qualifying property, and no bonus depreciation is allowable for any property in that same

property class and placed in service during that same taxable year. Accordingly, if a

taxpayer identifies tangible personal property in a cost segregation study that would

otherwise qualify for bonus depreciation, but that property was placed in service in the

same taxable year and is in the same class of property as a property for which the taxpayer

elected out of bonus depreciation, then the tangible personal property identified in the study

is deemed to be non-qualifying property.

Additionally, for tax years beginning before January 1, 2018, corporations may elect under

§ 168(k)(4) to accelerate the use of alternative minimum tax (AMT) credits in lieu of bonus

depreciation. Note, for tax years beginning after 2017, § 168(k)(4) is repealed.

140 | Page

Chapter 7 Industry Specific Guidance

The Contact information for internal communications regarding the various matrices have

been updated. Questions concerning these directives should be directed to the Deductible

and Capital Expenditures (DCE) Practice Network.

141 | Page

A. Casinos

Field Directive on Asset Class and Depreciation for Casino Construction Costs

LMSB-04-0706-005

July 11, 2006

MEMORANDUM FOR INDUSTRY DIRECTORS, LMSB

DIRECTOR, FIELD SPECIALISTS, LMSB

DIRECTOR, PREFILING AND TECHNICAL GUIDANCE, LMSB

DIVISION COUNSEL, LMSB

DIRECTOR, COMPLIANCE, SBSE

FROM: JoAnn Bank /s/ JoAnn G. Bank

Acting Industry Director, Communications, Technology & Media

SUBJECT: Field Directive on Asset Class and Depreciation for Casino Construction Costs

INTRODUCTION

This memorandum is intended to provide direction to effectively utilize resources in the classification and

examination of a taxpayer who is recovering construction costs through depreciation of tangible property used

in connection with a hotel/casino property.

RECOMMENDATIONS

The matrix included in this document contains recommendations for the categorization and lives of various

hotel/casino assets. If the taxpayer’s tax return position for these assets is consistent with these

recommendations, no adjustments should be made to categorizations and lives. If the taxpayer reports assets

differently, then adjustments should be considered.

EFFECT ON OTHER GUIDANCE

This directive should be applied in the context of other applicable depreciation principles. For example,

normal examination procedures should be followed to determine whether all appropriate costs, including IRC

§ 263A expenses, have been associated with a particular asset. Examiners are encouraged to exercise their

professional judgment when developing and resolving factual issues.

This memorandum is not an official pronouncement of the law or the Service’s position and cannot be used,

cited, or relied upon as such.

CONTACTS

If you have any questions, please have a member of your staff contact the Deductible and Capital

Expenditures (DCE) Practice Network.

Attachments

cc: Commissioner, LMSB

Deputy Commissioner, LMSB

Director, Performance, Quality and Audit Assistance

142 | Page

LMSB Directive on Cost Segregation in the Gaming Industry

This matrix, which is part of the Cost Segregation Audit Techniques Guide, is intended to provide direction to

effectively utilize resources in the classification and examination of property used in the operation of a

casino/hotel property. General fact patterns specific to this industry have been considered in the classification

of these assets and may not be applicable to other industries. Similarly, asset classification guidance issued

for other industries is based on the general fact pattern for that industry and may not be applicable to a

casino/hotel business situation. For example, for asset classification of restaurants located within a casino,

refer to the industry directive for restaurants. For examination techniques and historical background related to

this issue, refer to the Cost Segregation Audit Techniques Guide.

NOTE: In the case of certain leasehold improvement property, the classifications in this directive are

superseded to the extent that the American Jobs Creation Act of 2004 modifies IRC Section 168. Thus, a 15-

year straight line recovery period should replace the recovery period shown in the following matrix if the asset

is “qualified leasehold improvement property" (as defined in IRC Section 168(e)(6)) placed in service by the

taxpayer after 10/22/04 and before 1/1/08.

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

Ceilings

Dropped or lowered ceilings with decorative finishes

(such as ornamental polished gold and copper

metal

panels suspended from the finished ceiling or glued to

soffits or lowered drywall ceiling systems). The

suspension grids are hung by hanger wires from hooks

or eyes set in the floor above or bottom of the roof, and

attached to walls with nails or scr

ews. Components

such as lighting fixtures and air conditioning registers

are placed on the grid. The ceilings conceal plumbing,

wiring, sprinkler systems and air conditioning ducts.

Includes grid systems where the actual building ceiling

above the suspende

d ceiling can be seen. The actual

building ceiling is generally painted a dark color so as

to hide the various conduit, wires, and mechanical

systems hanging from it.

§ 1250

39 years

(40 years for

purposes of

§ 168 (g))

Doors and Door

Locks

Interior and exterior doors, regardless of decoration,

including but not limited to, double opening doors,

overhead doors, revolving doors, entrance security

gates, roll

-up or sliding wire mesh or steel grills and

gates, and door hardware (such as doorknobs, closers,

kick plates, hinges, locks, automatic openers, etc.).

Includes hotel guest room computerized door locks.

Includes encoders, computers, and other associated

hardware of the computerized lock system.

§ 1250

39 years

(40 years for

purposes of

§ 168 (g))

Doors and Door

Locks

Special lightweight, double action doors installed to

prevent accidents in a heavily trafficked area

(“Eliason”-type door). For example, flexible doors, clear

§ 1245

5 years

(57.0

Distributive

143 | Page

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

curtains, or strip curtains used between stock areas

and selling areas.

Trades and

Services)

Electrical

Hook-ups

(includes

duplex,

fourplex,

junction box,

conduit/wiring

and allocation

of panels)

Includes electrical outlets of general applicability and

accessibility located in

Accounting and Administrative

Offices, Ballrooms, “Back of House” areas, Pre

function

areas, and Support areas

(such as shop areas,

engineering and construction offices). Inc

ludes but is

not limited to outlets connected to copy machines, fax

machines, personal computers, break rooms, coffee

rooms, lounges, etc.

§ 1250

39 years

(40 years for

purposes of §

168 (g))

(includes duplex, fourplex, junction box,

conduit/wiring and allocation of panels)

Includes electrical outlets located in hotel guest rooms

and guest bathrooms of general applicability and

accessibility (includes bathroom GFI outlet).

§ 1250

39 years

(40 years for

purposes of §

168 (g))

(includes duplex, fourplex, junction box,

conduit/wiring and allocation of panels)

Includes electrical outlets specifically associated to

particular items of machinery and equipment located in

the Casino area. Includes ATM machines, slot

machines, and othe

r gaming related equipment. Also

includes all electrical hook

-ups associated with the

activities described in Asset Class 79.0 of Rev. Proc.

-56, 1987-2 CB 674, such as Theater and

Showroom.

§ 1245

7 years

(79.0

Recreation)

(includes duplex, fourplex, junction box,

conduit/wiring and allocation of panels)

Includes electrical outlets specifically associated to a

particular item of machinery or equipment located in

Conference Rooms, Guest Rooms, Public Facility

areas, Meeting Rooms, and Support

Areas, but not in

the Casino/Theater area. Examples include equipment

in Exercise rooms, ice machines, vending machines,

audio visual equipment, televisions (and the riser

conduit and wiring), garbage disposals, refrigerators,

and workbenches.

§ 1245

5 years

(57.0

Distributive

Trades and

Services)

Exit Signs

Signs posted along exit routes that indicate the

direction of travel to the nearest exit. These signs

typically read "EXIT" and may have distinctive colors,

illumination, or arrows

indicating the direction to the

exit.

§ 1250

39 years

(40 years for

purposes of §

168 (g))

Facades –

Exterior

Decorative exterior wall covering of the hotel/casino

complex to help create the theme for the hotel/casino

complex. Generally,

consists of a synthetic plaster, or

stucco, that is cemented, or in some cases, bolted on

in the form of a panel, to the frames of the exterior

walls of the buildings.

§ 1250

39 years

(40 years for

purposes of §

168 (g))

144 | Page

ASSET

ASSET 2 DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

Facades –

Interior

Columns

Includes finishes on interior columns that

are affixed with permanent adhesive or

nailed or screwed in place. Examples

include marble tile, millwork and other

coverings cemented, mudded, or grouted

to the column.

§ 1250

39 years

(40 years for

purposes of §

168 (g))

Facades –

Interior

Columns

Includes finishes on interior columns that

are not permanently attached and not

intended to be permanent. Located in the

Casino area. Also includes interior

columns associated with the activities

described in Asset Class 79.0 of Rev.

Proc. 87

-56, such as Theater and

Showroom.

§ 1245

7 years

(79.0

Recreation)

Facades –

Interior

Columns

Includes finishes on interior columns that

are not permanently attached and not

intended to be permanent. Not located in

the Casino/Theater area.

§ 1245

5 years

(57.0

Distributive

Trades and

Services)

Facades –

Interior

False

Balcony

Finishes generally made of millwork or

wrought iron (forged balconies and

gates) and located in the Casino area.

Also includes false balconies associated

with the activities described in Asset

Class 79.0 of Rev. Proc. 87

-56, such as

Theater and Showroom.

§ 1245

7 years

(79.0

Recreation)

Facades –

Interior

False

Balcony

Finishes generally made of millwork or

wrought iron (forged balconies and

gates). Not located in the Casino/Theater

area.

§ 1245

5 years

(57.0

Distributive

Trades and

Services)

Facades –

Interior

Storefronts

Includes the framework, sheetrock, or

any other component that comprises the

framing of the storefront walls.

§ 1250

39 years

(40 years for

purposes of

§ 168 (g))

Facades –

Interior

Storefronts

Includes storefronts made primarily of

synthetic materials (foam, fiberglass, cast

stone, or glass reinforced concrete) that

are affixed with permanent adhesive or

nailed or screwed in place. Also includes

costs relating to the exposed millwork,

trim moldi

ng and lining around doors,

windows, and baseboards. See also Wall

Coverings and Millwork.

§ 1250

39 years

(40 years for

purposes of

§ 168 (g))

145 | Page

ASSET

ASSET 2

DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

Facades –

Interior

(continued)

Storefronts

(continued)

Includes false storefronts made primarily

of synthetic materials (foam, fiberglass,

cast stone, or glass reinforced concrete)

that are not permanently attached and

not intended to be permanent. Located in

the Casino area. Also inclu

des

storefronts associated with the activities

described in Asset Class 79.0 of Rev.

Proc. 87

-56, such as Theater and

Showroom.

§ 1245

7 years

(79.0

Recreation)

Facades –

Interior

(continued)

Storefronts

(continued)

Includes false storefronts made primarily

of synthetic materials (foam, fiberglass,

cast stone, or glass reinforced concrete)

that are not permanently attached and

not intended to be permanent. Not

located in the Casino/Theater area.

§ 1245

5 years

(57.0

Distributive

Trades and

Services)

Facades –

Interior

(continued)

Painted

Ceilings

Includes painted ceilings applied with

spray guns and brushes (regardless of

theme or design).

§ 1250

39 years

(40 years for

purposes of

§ 168 (g))

Facades –

Interior

(continued)

Painted

Ceilings

Includes custom painted ceilings

designed on computers, transferred to

canvases, and hand

painted with acrylics

(fire-retardant materials).

§ 1250

39 years

(40 years for

purposes of

§ 168 (g))

Facades –

Interior

(continued)

Painted

Ceilings

Includes painted ceilings designed on

computers, transferred to canvases, and

hand

-painted with acrylics that are not

permanently attached and not intended

to be permanent and located in the

Casino area. Also includes painted

ceilings that are no

t permanently

attached associated with the activities

described in Asset Class 79.0 of Rev.

Proc. 87

-56, such as Theater and

Showroom.

§ 1245

7 years

(79.0

Recreation)

Facades –

Interior

(continued)

Painted

Ceilings

Includes painted ceilings designed on

computers, transferred to canvases, and

hand

-painted with acrylics that are not

permanently attached and not intended

to be permanent. Not located in the

Casino/Theater area.

§ 1245

5 years

(57.0

Distributive

Trades and

Services)

146 | Page

ASSET

ASSET 2

DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

Facades –

Interior

(continued)

Rockscape

Includes rock finishes made of synthetic

materials (such as interior fountains

containing waterproofed liners and

molded rockscape features) and

decorative stonework embedded in walls

that are an integral part of a buildings

structural shell. Includes non

-load

bearing rockscape and decorative

stonework embedded in walls

(regardless of height) that divide or

create rooms or provide traffic control

here the rockscape and stonework

cannot be 1) readily removed and remain

in substantially the same condition after

removal as before, or 2) moved and

reused, stored or sold in its entirety.

§ 1250

39 years

(40 years for

purposes of

§ 168 (g))

Facades –

Interior

(continued)

Rockscape

Includes rockscape and decorative

stonework that do not function as part of

the building and would be considered as

non

-structural theme elements that

function merely as ornamentation.

§ 1245

5 years

(57.0

Distributive

Trades and

Services)

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

Fire Protection

& Alarm

Systems

Includes sensing devices, computer controls, sprinkler

heads, piping or plumbing, pumps, visual and audible

alarms, alarm control panels, heat and smoke detection

devices, fire escapes, fire doors, emergency exit

lighting and signage, and wall mounted fire

extinguishers necessary for the protection of the

building.

§ 1250

39 years

(40 years for

purposes of §

168 (g)

Fire

Protection

Equipment

Includes special fire detection or suppression systems

directly associated with a piece of equipment. For

example, a fire extinguisher designed and used for

protection against a particular hazard created by the

business activity.

§ 1245

5 years

(57.0

Distributive

Trades and

Services)

Floor

Covering

Includes floor covering that is affixed with permanent

adhesive or nailed or screwed in place. Examples

include ceramic or quarry tile, marble, paving brick,

most vinyl coverings and other

coverings cemented,

mudded, or grouted to the floor; epoxy or sealers; and

wood flooring.

§ 1250

39 years

(40 years for

purposes of

§ 168 (g))

Floor

Covering

Includes floor covering that is not permanently attached

and not intended to be permanent, such as vinyl

composition tile (VCT) installed with strippable

adhesive, sheet vinyl, and carpeting, and located in the

Casino area. Also includes floor covering that is not

§ 1245

7 years

(79.0

Recreation)

147 | Page

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

permanently attached associated with the activities

described in Asset Class 79.0 of Rev. Proc. 87

-56,

such as Theater and Showroom.

Floor

Covering

(continued)

Includes floor covering that is not permanently attached

and not intended to be permanent, such as vinyl

composition tile (VCT) installed with strippable

adhesive, sheet vinyl, and carpeting, but not located in

the Casino/Theater area.

§ 1245

5 years

(57.0

Distributive

Trades and

Services)

Floors

Includes concrete slabs and other floor systems. Floors

include special treatments applied to or otherwise a

permanent part of the floor. For example, "super flat"

finish, sloped drainage basins, raised perimeter,

serving line curb, or cooler, free

zer and garbage room

floors.

§ 1250

39 years

(40 years for

purposes of

§ 168 (g))

Furniture -

Guest Room

Includes furniture unique to guest rooms and

distinguishable from office furniture. For example,

beds, dressers, armoires, and night

-tables. See also

Furniture

- Office.

§ 1245

5 years

(57.0

Distributive

Trades and

Services)

Furniture –

Office (includes

Communication

Equipment and

Hook-ups)

Includes desk, chair, credenza, file cabinet, table

(whether located in

Administrative Areas or Guest

Rooms

) and other furniture such as workstations. Also

includes communication equipment and related hook

ups.

§ 1245

7 years

(00.11 Office

Furniture and

Fixtures)

Generators

Emergency power generators for building related

operations (emergency/safety systems).

§ 1250

39 years

(40 years for

purposes of

§ 168 (g))

Generators

Depreciable assets, whether such assets are section

1245 property or 1250 property, used in the production

and/or distribution of electricity with rated total capacity

in excess of 500 Kilowatts and/or assets used in the

production and/or distribution of s

team with rated total

capacity in excess of 12,500 pounds per hour for use

by the taxpayer in its industrial manufacturing process

or plant activity and not ordinarily available for sale to

others. Does not include buildings and structural

components as de

fined in section 1.48-1(e) of the

regulations. See

Asset Class 00.4 (Rev. Proc. 87-56)

Note* asset class 00.4 includes both section 1245 and

1250 property per Rev. Proc. 87-56.

See Note*

15 years

(00.4

Industrial

Steam and

Electric

Generation

and/or

Distr

ibution

Systems)

Generators

Emergency power generators for casino operations.

(See

Cost Segregation Audit Techniques Guide for

allocation examples)

§ 1245

7 years

(79.0

Recreation)

Kitchen

Equipment

Hook-ups

Encompasses the electrical distribution system of the

kitchen. Refer to the industry directive for

Restaurants

- Kitchen Equipment Hook-up.

§ 1245

5 years

(57.0

Distributive

148 | Page

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

Trades and

Services)

Light

Fixtures –

Interior

Includes lighting such as recessed and lay-in lighting,

night lighting, and exit lighting, as well as decorative

lighting fixtures that provide substantially all the artificial

illumination (

primary source of lighting). Includes guest

room lighting, wall sconces (bathroom, guest room, and

hallway), hallway chandeliers, and all electrical

connections associated with these fixtures, such as

power junction boxes, riser conduit, and wiring.

§ 1250

39 years

(40 years for

purposes of

§ 168 (g))

Light

Fixtures –

Interior

Includes decorative light fixtures such as chandeliers,

wall sconces, down lighting, neon lighting, column

lights which are decorative in nature and not necessary

for the operation of the building and located in the

Casino area plus cost of all wiring and

electrical

connections associated with these fixtures. Also

includes all decorative lighting fixtures associated with

the activities described in Asset Class 79.0 of Rev.

Proc. 87-56, such as Theater and Showroom.

§ 1245

7 years

(79.0

Recreation)

Light

Fixtures –

Interior

Includes decorative light fixtures, such as neon lights,

table lamps, or track lighting, which are decorative in

nature and not necessary for the operation of the

building and not located in the Casino/Theater area. In

other wo

rds, if the decorative lighting were turned off,

the other sources of lighting would provide sufficient

light for operation of the building. If the decorative

lighting is the

primary source of lighting, then it is

section 1250 property.

§ 1245

5 years

(57.

Distributive

Trades and

Services)

Light

Fixtures –

Exterior

Exterior lighting (whether decorative or not) to the

extent that the lighting relates to the maintenance or

operation of the building. This category includes

building mounted lighting to

illuminate walkways,

entrances, parking, etc.

§ 1250

39 years

(40 years for

purposes of

§ 168 (g))

Light

Fixtures –

Exterior

Pole mounted or freestanding outdoor lighting system

to illuminate sidewalks, parking or recreation areas.

See also

Poles & Pylons

. Note* asset class 00.3 Land

improvements includes both section 1245 and 1250

property per Rev. Proc. 87-56.

See Note*

15 years

(00.3 Land

Improvement)

Light

Fixtures –

Exterior

Removable plant grow lights or removable lighting that

highlights

only the landscaping or building exterior (but

not parking areas or walkways) and does not relate to

the maintenance or operation o

f the building.

§ 1245

5 years (57.0

Distributive

Trades and

Services)

Loading Dock

Includes bumpers, permanently installed dock levelers,

plates, seals, lights, canopies, and overhead doors

used in the receiving and shipping of merchandise.

§ 1250

39 years

(40 years for

purposes of

§ 168 (g))

Loading Dock

Includes items such as compactors, conveyors, hoists

and/or balers.

§ 1245

5 years

149 | Page

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

(57.0

Distributive

Trades and

Services)

Millwork –

General

Building or

Structural

Includes millwork that is made of finished wood for

example, doors and frames, window frames, sashes,

porch work, mantels, panel work, stairways, and

special woodwork. Includes pre

-built wooden items

brought to the site for installation and items constructed

on site such as restroo

m cabinets, door jambs,

moldings, trim, etc.

§ 1250

39 years

(40 years for

purposes of

§ 168 (g))

Millwork –

General Building

or Structural

Corner Guards and Wall Guards (includes guards

made of stainless steel, e.g., diamond plate)

§ 1250

39 years

(40 years for

purposes of

§ 168 (g))

Millwork -

Decorative

Includes decorative finish carpentry in a Casino area.

Examples include detailed crown moldings, lattice work

placed over finished walls or ceilings, and cabinets.

The decorative millwork serves to enhance the overall

décor of the Casino area and is not re

lated to the

operation of the building. Cabinets and counters in a

restroom are excluded from this category; see

Restroom Accessories.

Also includes decorative

millwork associated with the activities described in

Asset Class 79.0 of Rev. Proc. 87

-56, such as Theater

and Showroom.

§ 1245

7 years

(79.0

Recreation)

Millwork -

Decorative

Includes decorative finish carpentry in the hotel and

retail

areas. Examples include detailed crown

moldings, lattice work placed over finished walls or

ceilings, and cabinets. The decorative millwork serves

to enhance the overall décor of the hotel and retail

areas and is not related to the operation of the building.

Cabinets and counters in a restroom are excluded from

this category; see Restroom Accessories.

§ 1245

5 years

(57.0

Distributive

Trades and

Services)

Poles &

Pylons

Light poles for parking areas and other poles poured in

concrete footings or bolt

-mounted for signage, flags,

etc. Note* asset class 00.3 Land improvements

includes both section 1245 and 1250 property per Rev.

Proc. 87

-56. See also Pylon Sign – Exterior and

Light Fixtures – Exterior.

See Note*

15 years

(00.3 Land

Improvement)

Pools & Pool

Equipment

Includes swimming pools and pool equipment (and

spas attached to the swimming pools) that are

contained within, on, or attached to a building.

§ 1250

39 years

(40 years for

purposes of

§ 168 (g))

Pools & Pool

Equipment

Includes exterior swimming pools and pool equipment

(and spas attached to the swimming pools) that are

built on land. Note* asset class 00.3 Land

See Note*

15 years

(00.3 La

Improvement)

150 | Page

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

improvements includes both section 1245 and 1250

property per Rev. Proc. 87-56.

Pylon Sign -

Exterior

Pylons made of concrete, brick, wood frame, stucco, or

similar materials usually set in the ground or on a

concrete foundation, and usually used for signage.

Note* asset class 00.3 Land improvements includes

both section 1245 and 1250 property per Rev. Pro

87-56. See also Poles & Pylons

See Note*

15 years

(00.3 Land

Improvement)

Pylon Sign -

Exterior

Includes only the sign face and/or message screen and

related components.

§ 1245

5 years

(57.0

Distributive

Trades and

Services)

Restroom-

Accessories

Includes paper towel dispensers, electric hand dryers,

towel racks or holders, cup dispensers, purse shelves,

toilet paper holders, soap dispensers or holders, lotion

dispensers, sanitary napkin dispensers and waste

receptacles, coat hooks, han

drails, grab bars, mirrors,

shelves, vanity cabinets, counters and ashtrays and

other items generally found in public restrooms that are

built into or mounted on walls or partitions.

§ 1250

39 years

(40 years for

purposes of

§ 168 (g))

Restroom

Partitions

Includes shop made and standard manufacture toilet

partitions, typically metal, but may be plastic or other

materials.

§ 1250

39 years

(40 years for

purposes of

§ 168 (g))

Security

Equipment

Includes security equipment for the protection of the

building and its contents, including the building exterior

and grounds, from theft or vandalism and protection of

employees and guests from assault. Examples include

security cameras, recorders, monitors and related

equipment (including t

hose located in the elevator and

elevator lobbies); building exterior and interior motion

detectors; security lighting; alarm systems; security

systems and related junction boxes, wiring, and

conduit).

§ 1250

39 years

(40 years for

purposes of

§ 168 (g)

Security

Equipment

(continued)

Includes surveillance cameras, recorders, monitors and

related equipment, the primary purpose of which is to

surveil gaming activities and to minimize theft in the

Casino area. Also includes surveillance

equipment

associated with the activities described in Asset Class

79.0 of Rev. Proc. 87

-56, such as Theater and

Showroom.

§ 1245

7 years

(79.0

Recreation)

Security

Equipment

(continued)

Includes electronic article surveillance systems

including surveill

ance cameras, recorders, monitors

and related equipment, the primary purpose of which is

to minimize theft in the

retail areas. Does not include

the Casino/Theater area.

§ 1245

5 years

(57.0

Distributive

Trades and

Services)

151 | Page

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

Signs

Exit signs, restroom identifiers, room numbers, and

other signs relating to the operation or maintenance of

a building. See also

Exit Signs.

§ 1250

39 years

(40 years for

purposes of

§ 168 (g))

Signs

Includes interior signs used to display gaming related

activities such as keno, slots, video poker, etc. Also

includes interior signs associated with the activities

described in Asset Class 79.0 of Rev. Proc. 87

-56,

such as Theater and Showroom.

§ 1245

7 years

(79.0

Recreation)

Signs

Includes interior signs used to display directories of

names or indicate the location of business functions

and departments, (registration desk, buffet, retail

shops, etc.), but not associated with the

Casino/Theater activities. Not related to the operatio

or maintenance of a building. Also includes exterior

signs used to display names, symbols, directions, etc.

For pylon signs, includes only the sign face and related

dedicated wiring. See also Pylon Sign – Exterior.

§ 1245

5 years

(57.0

Distributive

Trade

s and

Services)

Site Grading &

Excavation

Non-depreciable land preparation costs, in general,

include the one

-time cost of demolition, clearing and

grubbing, blasting, site stripping, fill or excavation,

dewatering, and grading to allow

development of land.

Clearing and grubbing is the removal of debris, brush,

trees, etc. from the site. Stripping is the removal of the

topsoil to provide a stable surface for site and building

improvements. The grading of land involves moving

soil for the

purpose of producing a more level surface

to allow development of the land. These costs would

not have to be incurred again if the building was

repaired, rebuilt, or even torn down and replaced with

some other type of building.

Land

Site Grading &

Excavation

(continued)

Clearing, grading, excavating and removal costs

directly associated with the construction of buildings

and building components are part of the cost of

construction of the building and depreciated over the

life of the building.

§ 1250

39 years

(40 years for

purposes of

§ 168 (g))

Site Grading &

Excavation

(continued)

Clearing, grading, excavating and removal costs

directly associated with the construction of sidewalks,

parking areas, roadways and other depreciable land

improvements are part of the cost of construction of the

improvements and depreciated over the life o

f the

associated asset.

Note* asset class 00.3 Land

improvements includes both section 1245 and 1250

property per Rev. Proc. 87-56.

See Note*

15 years

(00.3 Land

Improvement)

Site Utilities

Systems that are used to distribute utility services from

the property line to the casino complex. Includes water,

sanitary sewers, gas and electrical services.

§ 1250

39 years

(40 years for

purposes of

§ 168 (g)

152 | Page

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

Site Utilities

Storm Piping (for draining the site of rainwater). Note*

asset class 00.3 Land

improvements includes both

section 1245 and 1250 property per Rev. Proc. 87-56.

See Note*

15 years

(00.3 Land

Improvement)

Site Work

Site work includes curbing, paving, general site

improvements, fencing, landscaping, roads, sewers,

sidewalks, site drainage and all other site

improvements not directly related to the building.

Note*

asset class 00.3 Land improvements includes both

sectio

n 1245 and 1250 property per Rev. Proc. 87-56.

See Site Utilities for sanitary sewers.

See Note*

15 years

(00.3 Land

Improvement)

Spa Hook-ups

Includes Jacuzzi, Whirlpools, and bathtubs located in

Guest Rooms and Suites.

§ 1250

39 years

(40 years

for

purposes of

§ 168 (g))

Spa Hook-ups

Includes Jacuzzi and Whirlpools located in the Hotel

Spa/Fitness Center

. Does not include spa hook-ups

that may be associated with swimming pools or pool

equipment. See also

Pools & Pool Equipment.

§ 1245

5 years

(57.0

Distributive

Trades and

Services)

Wall

Coverings

Includes interior and exterior paint; ceramic or quarry

tile, marble, stone, brick and other finishes affixed with

mortar, cement or grout; paneling, wainscoting and

other wood finishes affixed with nails, screws or

permanent adhesives; and sanitary kitchen wall panels

such as fiberglass, stainless steel

and plastic wall

panels.

§ 1250

39 years

(40 years for

purposes of

§ 168 (g))

Wall

Coverings

(continued)

Includes strippable wall paper and vinyl that causes no

damage to the underlying wall or wall surface and

located in the Casino area. For

purposes of this

directive, such wallpaper is considered not permanently

attached or intended to be permanent. Also includes

strippable wall coverings associated with the activities

described in Asset Class 79.0 of Rev. Proc. 87

-56,

such as Theater and Showroom.

§ 1245

7 years

(79.0

Recreation)

Wall

Coverings

(continued)

Includes strippable wallpaper and vinyl that causes no

damage to the underlying wall or wall surface and

located in the

hotel and retail areas. For purposes of

this directive, such wallpa

per is considered not

permanently attached or intended to be permanent.

§ 1245

5 years

(57.0

Distributive

Trades and

Services)

153 | Page

B. Restaurants

Field Directive on the Planning and Examination of Cost Segregation Issues in the

Restaurant Industry

December 27, 2004

MEMORANDUM FOR INDUSTRY DIRECTORS, LMSB

DIRECTORS, FIELD OPERATIONS, LMSB

DIRECTOR, FIELD SPECIALISTS, LMSB

DIRECTOR, PREFILING AND TECHNICAL GUIDANCE, LMSB

DIRECTOR, COMPLIANCE, SBSE

FROM: /s/ Henry V. Singleton

Industry Director

/s/ Steve Burgess

Director, Examination, SBSE

SUBJECT: Field Directive on the Planning and Examination of Cost Segregation Issues in the Restaurant

Industry

INTRODUCTION

This memorandum is intended to provide direction to effectively utilize resources in the classification and

examination of a taxpayer who is recovering costs through depreciation of tangible property used in the

operation of a restaurant business. This LMSB Directive is not an official pronouncement of the law or the

position of the Service and cannot be used, cited or relied upon as such.

The American Jobs Creation Act of 2004, enacted October 22, 2004, modifies I.R.C. §168. This development

has been incorporated into the guidelines through the note to Exhibit A. In addition, this directive has been

modified in content and format to conform to the Field Directive issued for the retail industry on December 16,

2004.

BACKGROUND

The crux of cost segregation is determining whether an asset is I.R.C. §1245 property (shorter cost recovery

period property, 5 or 7 years) or §1250 property (longer cost recovery period property, 39, 31.5 or 15 years).

The most common example of §1245 property is depreciable personal property, such as equipment. The

most common examples of §1250 property are buildings and building components, which generally are not

§1245 property.

The difference in recovery periods has placed the Internal Revenue Service and taxpayers in adversarial

positions in determining whether an asset is §1245 or §1250 property. Frequently, this causes the excessive

expenditure of examination resources. The Director for the Retailers, Food, Pharmaceuticals and Healthcare

Industry chartered a working group to address the most efficient way to approach cost segregation issues

I.R.C. Section 1245 can apply to certain qualified recovery nonresidential real estate placed in service after

1980 and before 1987. See I.R.C. Section 1245(a)(5).

154 | Page

specific to the restaurant industry. The group produced the attached matrix and related definitions as a tool to

reduce unnecessary disputes and foster consistent audit treatment.

PLANNING AND EXAMINATION GUIDANCE

Attached Exhibit A is a matrix recommending the categorization and general depreciation system recovery

period of various restaurant assets. (For recovery periods under IRC §168(g) alternative depreciation system

see Revenue Procedure 87-56, 1987-2 CB 674.) If the taxpayer’s tax return position for these assets is

consistent with the recommendations in Exhibit A, examiners should not make adjustments to categorization

and lives. If the taxpayer reports assets differently, then adjustments should be considered. The Industry

intends to update Exhibit A regularly.

See the Cost Segregation Audit Techniques Guide for additional guidance. See also Revenue Procedure

2002-12, I.R.B. 2002-3, 374 (Jan. 07, 2002), for the proper treatment of smallwares.

If you have any questions, please contact the Deductible and Capital Expenditures (DCE) Practice Network.

Attachments: Exhibit A

LMSB DIRECTIVE ON COST SEGREGATION IN THE RESTAURANT INDUSTRY

EXHIBIT A

NOTE: In the case of certain leasehold improvements and restaurant property, the classifications in this

directive are superseded to the extent that the American Jobs Creation Act of 2004 modifies IRC Section 168.

Thus, a 15-year straight line recovery period should replace the recovery period shown in the following matrix

if the asset is “qualified leasehold improvement property" (as defined in IRC Section 168(e)(6)) or “qualified

restaurant property” (as defined in IRC Section 168(e)(7)) placed in service by the taxpayer after October 22,

2004 and before January 1, 2008.

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

Beverage

Equipment

Equipment for storage and preparation of beverages

and beverage delivery systems. Beverage equipment

includes the refrigerators, coolers, dispensing

systems, and the dedicated electrical, tubing or

piping for such equipment. The dispensing system

may be gravity, pump or gas driven.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Canopies &

Awnings

Readily removable overhang or covering, often of

canvas or plastic, used to provide shade or cover

over a storefront, window, or door; or

used inside a

structure to identify a particular area. Examples

include applications over an exterior door or window,

or attached to interior walls or suspended from

ceilings to identify a buffet line or bar area of the

restaurant. Does not include canopi

es that are an

integral part of a building’s structural shell, such as in

the casino industry, or over docks.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Ceilings

Includes all interior ceilings regardless of finish or

décor, e.g. drywall or p

laster ceilings, acoustic

ceilings, suspended ceilings (including all hangers,

frames, grids, and tiles or panels), decorative metal

or tin finishes, kitchen plastic panels, decorative

panels, etc.

§ 1250

Building or

Building

Component

–

39 Years

155 | Page

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

Computers

Processors (CPU), direct access storage device

(DASD), tape drives, desktop and laptop computers,

CRT, terminals, monitors, printers, and other

peripheral equipment. Excludes Point of Sale (POS)

systems and computers that are an integral part of

other equipment (e.g., fire detection, heating,

cooling, or energy management systems, etc.).

§ 1245

00.12

Information

Systems

–

5 Years

Concrete

Foundations &

Footings

Includes formwork, reinforcement, concrete block,

and pre

-cast or cast-in-place work related to

foundations and footings necessary for the proper

setting of the building.

§ 1250

Building or

Building

Component

–

39 Years

Concrete

Foundations &

Footings

Foundations or footings for signs, light poles,

canopies and other land

improvements (except

buildings).

§ 1250

00.3 Land

Improvements

–

15 Years

Data Handling

Equipment

Includes adding and accounting machines,

calculators, copiers and duplicating machines.

Excludes computers and computer peripheral

equipment, see

Computers.

§ 1245

00.13 Data

Handling

Equipment,

except

Computers

–

5 Years

Doors

Interior and exterior doors, regardless of decoration,

including but not limited to, double opening doors,

overhead doors, revolving doors, mall entrance

security gates, roll

-up or sliding wire mesh or steel

grills and gates, and door hardware (such as

doorknobs, close

rs, kick plates, hinges, locks,

automatic openers, etc.).

§ 1250

Building or

Building

Component

–

39 Years

Doors

Special lightweight, double action doors installed to

prevent accidents in a heavily trafficked area. For

example, Eliason doors

providing easy access

between the kitchen and dining areas.

§ 1245

57.0

Distributive

Trades and

Services

–

5 Years

Doors – Air

Curtains

Air doors or curtains are air systems located above

doors and windows that circulate air to stabilize

environments and save energy by minimizing the

heated/air conditioned air loss through open

doorways and windows. They also effectively repel

flying insects, dust, and pollutants.

§ 1250

Building or

Building

Component

–

39 Years

Drive-Through

Equipment

Drive-through equipment includes order taking, food

delivery and payment processing systems whether

mechanical or electronic. Excludes building elements

such as doors, bays, or windows. See also

Walls –

Exterior

, and Windows for drive-through bays and

windows.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Electrical

Includes all components of the building electrical

system used in the operation or maintenance of the

building or necessary to provide general building

services such as electrical outlets of general

§ 1250

Building or

Building

Component

–

39 Years

156 | Page

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

applicability and accessibility, lighting, heating,

ventilation, air conditioning and electrical wiring. See

also Kitchen Equipment Hook-ups.

Electrical

Special electrical connections which are necessary

to and used directly with a specific item of machinery

or equipment or connections between specific items

of individual machinery or equipment; such as

dedicated electrical outlets, wiring, conduit, and

circuit br

eakers by which machinery and equipment

is connected to the electrical distribution system.

Does not include electrical outlets of general

applicability and accessibility. See Chapter 5 of the

Cost Segregation Audit Techniques Guide for

allocation examples.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Elevators &

Escalators

Elevators and escalators, which include handrails

and smoke baffles, are permanently affixed to the

building and intended to remain in place. They relate

to the operation o

r maintenance of the building and

are structural components.

§ 1250

Building or

Building

Component

–

39 Years

Equipment

Installation

Expenses incurred in the installation of furnishings

and restaurant equipment. Some examples include

booths,

tables, counters and interior theme décor.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Exit Signs

Signs posted along exit routes that indicate the

direction of travel to the nearest exit. These signs

typically read "EXIT" and may have distinctive colors,

illumination, or arrows indicating the direction to the

exit.

§ 1250

Building or

Building

Component

–

39 Years

Fire Protection

& Alarm

Systems

Includes sensing devices, computer controls,

sprinkler heads, piping or plumbing, pumps, visual

and

audible alarms, alarm control panels, heat and

smoke detection devices, fire escapes, fire doors,

emergency exit lighting and signage, and wall

mounted fire extinguishers necessary for the

protection of the building.

§ 1250

Building or

Building

Component

–

39 Years

Fire Protection

Equipment

Includes special fire detection or suppression

systems located in equipment hoods or directly

associated with a piece of equipment.

For example,

a fire extinguisher designed and used for protection

against a

particular hazard created by the business

activity.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Fireplaces

Includes masonry and gas fireplaces, flues,

chimneys and other components of built

-in

fireplaces.

§ 1250

Building or

Building

Component

–

39 Years

157 | Page

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

Floor

Coverings

Floor covering affixed with permanent adhesive,

nailed, or screwed in place. Examples include

ceramic or quarry tile, marble, paving brick, and

other coverings cemented, mudded, or grouted to the

floor; epoxy or sealers; and wood flooring.

§ 1250

Building or

Building

Component

–

39 Years

Floor

Coverings

Floor covering that is installed by means of strippable

adhesives. For the restaurant industry, all carpeting

will be treated as not permanently attached and

not

intended to be permanent. Excludes rugs or

tapestries that are considered artwork and do not

suffer wear and tear (e.g. Persian rugs that may

appreciate are considered artwork).

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Floors

Includes concrete slabs and other floor systems.

Floors include special treatments applied to or

otherwise a permanent part of the floor. For example,

"superflat" finish, sloped drainage basins, raised

perimeter, serving line curb, or cooler, freezer and

garbage room floors.

§ 1250

Building or

Building

Component

–

39 Years

Food Storage &

Preparation

Equipment

Food storage, cleaning, preparation, and delivery

systems including all machinery, equipment, furniture

and fixtures used to process food items

from storage

through delivery to the customer.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Heating

Ventilating & Air

Conditioning

(HVAC)

Includes all components of a central heating,

ventilating and air conditioning system not

specifically id

entified elsewhere. HVAC systems that

are installed not only to meet the temperature and

humidity requirements of machinery, but are also

installed for additional significant purposes, such as

customer comfort and ventilation, are building

components.

§ 1250

Building or

Building

Component

–

39 Years

Heating

Ventilating & Air

Conditioning

(HVAC)

Only separate kitchen HVAC units that meet the sole

justification test are included (i.e., machinery the sole

justification for the installation of which is the fact that

such machinery is required to meet temperature or

humidity requirements which are ess

ential for the

operation of other machinery or the processing of

materials or foodstuffs.) Kitchen HVAC may meet the

sole justification test even though it incidentally

provides for the comfort of employees, or serves, to

an insubstantial degree, areas whe

re such

temperature or humidity requirements are not

essential. Includes refrigeration units, condensers,

compressors, accumulators, coolers, pumps,

connecting pipes, and wiring for the mechanical

equipment for climate controlled rooms such as walk

in free

zers and coolers. Allocation of HVAC is not

appropriate.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

158 | Page

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

Kitchen

Equipment

Hook-ups

Includes separate water lines from the incoming

water main to equipment (such as steam trays,

cooking vessels, or ice machines), gas lines from the

building’s main gas line to equipment (such as fryers

or ovens), and special drain lines from equipment

(such as refrigerator or dishwasher) to the drain. Also

includes ventilation system or kitchen air makeup

unit solely to maintain specific ventilation

requirements essential for operation of kitchen

equipment, equipment exhaust hoods, and electric

outlets and

conduit extending back to the circuit box

to provide a localized power source for specialized

equipment. For example, a dishwasher requires

electric and plumbing hook

-ups, electrical from the

dishwasher to the source of electricity (such as an

outlet or j

unction box), and plumbing to connect the

dishwasher to the water line and the drain. Excludes

outlets of general applicability and accessibility or

kitchen hand sink plumbing; see also

Electrical,

HVAC, and Plumbing.

§ 1245

57.0

Distributive

Trades and

ervices --

5 Years

Light Fixtures –

Interior

Includes lighting such as recessed and lay-in lighting,

night lighting,

and exit lighting, as well as decorative

lighting fixtures that provide substantially all the

artificial illumination in the building or along building

walkways. For emergency and exit

lighting, see Fire

Protection & Alarm Systems.

§ 1250

Building or

Building

Component

–

39 Years

Light Fixtures –

Interior

Decorative light fixtures are light fixtures, such as

neon lights or track lighting, which are decorative in

nature and not necessary for the operation of the

building. In other words, if the decorative lighting

were turned off, the other sources of lighti

ng would

provide sufficient light for operation of the building. If

the decorative lighting is the

primary source of

lighting, then it is section 1250 property.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Light Fixtures –

Exterior

Exterior lighting whether decorative or not is

considered section 1250 property to the extent that

the lighting relates to the maintenance or operation

of the building. Includes building mounted lighting to

illuminate walkways, entrances, parking, etc.

§ 1250

Building or

Building

Component

–

39 Years

Light Fixtures –

Exterior

Pole mounted or freestanding outdoor lighting

system to illuminate sidewalks, parking or recreation

areas. See also

Poles & Pylons. Note* asset class

00.3 Land improvements includes both section 1245

and 1250 property per Rev. Proc. 87-56.

See Note*

00.3 Land

Improvements

–

15 Years

Light Fixtures –

Exterior

Plant grow lights or lighting that highlights only the

landscaping or building exterior (but not parking

areas or walkways) does not relate to the

maintenance or operation of the building

§ 1245

57.0

Distributive

Trades and

Services

5 Years

159 | Page

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

Millwork –

Decorative

Decorative millwork is the decorative finish carpentry

in the restaurant. Examples include detailed crown

moldings, lattice work placed over finished walls or

ceilings, cabinets and counters. The decorative

millwork serves to enhance the overall theme of t

restaurant and is not related to the operation of the

building. Excludes cabinets and counters in a

restroom; see Restroom Accessories.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Millwork –

General

Building or

Structural

General millwork is all building materials made of

finished wood (e.g., doors and frames, window

frames, sashes, porch work, mantels, panel work,

stairways, and special woodwork). Includes pre

-built

wooden items brought to the site for installation and

items const

ructed on site such as restroom cabinets,

door jambs, moldings, trim, etc.

§ 1250

Building or

Building

Component

–

39 Years

Office

Furnishings

Includes desk, chair, credenza, file cabinet, table, or

other furniture

such as workstations. Also includes

tele

phone equipment, fax machines, and other

communications equipment. Does not include

communications equipment included in other asset

classes in Rev. Proc. 87-56.

§ 1245

00.11 Office

Furniture,

Fixtures, and

Equipment

–

7 Years

Parking Lots

Grade level surface parking area usually constructed

of asphalt, brick, concrete, stone or similar material.

Category includes bumper blocks, curb cuts, curb

work, striping, landscape islands, perimeter fences,

and sidewalks.

§ 1250

00.3 Land

Improvements

–

15 Years

Plumbing

All piping, drains, sprinkler mains, valves, sprinkler

heads, water flow switches, restroom plumbing

fixtures (e.g. toilets) and piping, kitchen hand sinks,

electric water coolers, and all other components of a

building plumbing system (water

or gas) not

specifically identified elsewhere. Excludes water or

gas connections directly to appliances or kitchen

drainage and kitchen hot water heater; see

Kitchen

Equipment Hook-ups.

§ 1250

Building or

Building

Component

–

39 Years

Plumbing

Includes water, gas, or refrigerant hook-ups directly

connected to appliances or equipment, eyewash

stations, kitchen drainage, and kitchen hot water

heater. For example, a dishwasher would require

special water hook-up.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Point of Sale

(POS) Systems

A register or terminal based data collection system

used to control and record all sales. Includes cash

registers, computerized sales systems, and related

peripheral equipment. See also

Electrical for hook-

ups.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Poles & Pylons

Light poles for parking areas and other poles poured

in concrete footings or bolt

-mounted for signage,

flags, etc. Note* asset class 00.3 Land

See Note*

00.3 Land

Improvements

–

160 | Page

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

Improvements includes both section 1245 and 1250

property per Rev. Proc. 87-56.

15 Years

Restaurant

Décor

Accessories

Decorative mobile props such as playground

equipment, potted plants, hanging mirrors, ceiling

fans, and theme related props (such as coat of arms,

sporting equipment or memorabilia, artifacts,

pictures, plaques, etc

., excluding non-depreciable

artwork, antiques or collectibles).

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Restaurant

Furniture

Includes furniture unique to restaurants and

distinguishable from office furniture. For example, a

high stool in a bar, dining room table and chairs,

booths, lockers, or benches. See also

Office

Furnishings.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Restaurant

Non-structural

Theme Elements

Interior non-load bearing decorative structures.

These are items that do not function as part of the

building and are not integrated with building

elements such as wiring, plumbing or ventilation. For

exam

ple, a model castle constructed of gypsum

board or plaster and wood studs would be

considered a non

-structural theme element that

functions merely as ornamentation. Excludes a half

wall whose function is to provide traffic control or

space subdivision, see

Walls - Interior Partitions.

Excludes decorative ceilings, see Ceilings.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Restroom

Accessories

Includes paper towel dispensers, electric hand

dryers, towel racks or holders, cup dispensers, purse

shelves, toilet paper holders, soap dispensers or

holders, lotion dispensers, sanitary napkin

dispensers and waste receptacles, coat hooks, grab

bars, mirrors, shelves, vanity cabinets, counters,

ashtrays,

baby changing stations, and other items

generally found in public restrooms that are built into

or mounted on walls or partitions.

§ 1250

Building or

Building

Component

–

39 Years

Restroom

Partitions

Includes shop made and standard manufacture toilet

partitions, typically metal, but may

be plastic or other

materials.

§ 1250

Building or

Building

Component

–

39 Years

Roof

All elements of the roof including but not limited to

joists, rafters, deck, shingles, vapor barrier, skylights,

trusses, girders and gutters. Determination of

whether decorative elements of a roof (e.g. false

dormers, mansard) constitute structural buildi

components depends on their integration with the

overall roof not their load bearing capacity. If removal

of the decorative element results in the direct

exposure of building components to water, snow,

wind, or moisture damage, or if the decorative

elem

ent houses lighting fixtures, wiring, or other

structural components, then the decorative elements

§ 1250

Building or

Building

Component

–

39 Years

161 | Page

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

are part of the overall roof system and are structural

components of the building.

Security

Systems

Includes security equipment for the protection of the

building (and its contents) from

burglary or vandalism

and protection of employees from assault. Examples

include window and door locks; card key access

systems; keyless entry systems; security cameras,

record

ers, monitors and related equipment;

perimeter and interior building motion detectors;

security lighting; alarm systems; and security system

wiring and conduit.

§ 1250

Building or

Building

Component

–

39 Years

Signs

Exit signs, restroom identifiers and other signs

relating to the operation or maintenance of a

building.

§ 1250

Building or

Building

Component

–

39 Years

Signs

Interior and Exterior Signs used for menu display or

theme identity.

For pylon signs, includes only sign face. See also

Poles & Pylons

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Site Preparation,

Grading, &

Excavation

In general, land preparation costs include one-time

cost of clearing and grubbing, site

stripping, fill or

excavation, and grading to allow development of

land. Clearing and grubbing is the removal of debris,

brush, trees, etc. from the site. Stripping is the

removal of the topsoil to provide a stable surface for

site and building improvement

s. The grading of land

involves moving soil to produce a more level surface

to allow development of the land.

Land

Site

Preparation,

Grading, &

Excavation

Clearing, grading, excavating and removal costs

directly associated with the

construction of buildings

and building components are part of the cost of

construction of the building.

§ 1250

Building or

Building

Component

–

39 Years

Site

Preparation,

Grading, &

Excavation

Clearing, grading, excavating and removal costs

directly associated with the construction of

sidewalks, parking areas, roadways and other

depreciable land improvements are part of the cost

of construction of the improvements.

§ 1250

00.3 Land

Improvements

–

15 Years

Site Utilities

Site utilities are the systems that are used to

distribute utility services from the property line to the

restaurant building. Includes water, sanitary sewer,

gas, and electrical services.

§ 1250

Building or

Building

Component

–

39 Years

Site Work

Site work includes curbing, paving, general site

improvements, fencing, landscaping, roads, sewers,

sidewalks, site drainage and all other site

improvements not directly related to the building. For

sanitary sewers, see Site Utilities.

§ 1250

00.3 Land

Improvements

–

15 Years

162 | Page

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

Sound Systems

Equipment and apparatus, including wiring, used to

provide amplified music or sound. For example,

public address by way of paging a customer or

background music. Excludes applications linked to

fire protection and alarm systems.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Stonework

Exterior decorative stonework embedded in half

walls, such as patio half walls, that are an integral

part of a building’s structural shell. Such half walls

relate to the

operation or maintenance of the

building.

§ 1250

Building or

Building

Component

–

39 Years

Stonework

Includes patio stonework imbedded in the ground or

applied to exterior half walls that are not an integral

part of the building’s structural shell.

§ 1250

00.3 Land

Improvements

–

15 Years

Trash

Enclosures

Enclosures for waste receptacles that are attached to

the building. Typically constructed of the same

materials as the building shell with either interior or

exterior access. These trash

enclosures are an

integral part of the building shell and cannot be

moved without damage to the underlying building.

§ 1250

Building or

Building

Component

–

39 Years

Trash

Enclosures

Freestanding enclosures for waste receptacles,

typically

constructed on a concrete pad with its posts

set in the concrete. Serves both safety and

decorative functions.

§ 1250

00.3 Land

Improvements

–

15 Years

Upholstery

Any material used in the coverage and protection of

furnishings.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Wall Coverings

Includes interior and exterior paint; ceramic or quarry

tile, marble, stone, brick and other finishes affixed

with mortar, cement or grout; paneling, wainscoting

and other wood finishes

affixed with nails, screws or

permanent adhesives; and sanitary kitchen wall

panels such as Fiberglass Reinforced Plastic (FRP),

stainless steel or plastic wall panels.

§ 1250

Building or

Building

Component

–

39 Years

Wall Coverings

Strippable wallpaper that causes no damage to the

underlying wall or wall surface.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Walls – Exterior

Includes all exterior walls and building support

regardless of construction materials. Exterior walls

may

include columns, posts, beams, girders, curtain

walls, tilt up panels, studs, framing, sheetrock,

insulation, windows, doors, exterior façade, brick,

masonry, etc. Also includes drive

-through bay,

windows, and doors.

§ 1250

Building or

Building

Component

–

39 Years

163 | Page

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

Walls - Interior

Partitions

Includes all load bearing interior partitions regardless

of construction. Also includes non

-load bearing

partitions regardless of height (typically constructed

of studs and sheetrock or other materials) that

divide

or create rooms or provide traffic control. Includes

rough carpentry and plaster, dry wall or gypsum

board, and other finishes.

§ 1250

Building or

Building

Component

–

39 Years

Walls - Interior

Partitions

Interior walls where the partition can be 1) readily

removed and remain in substantially the same

condition after removal as before, or 2) moved and

reused, stored or sold in its entirety.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Windows

Exterior windows, including store front windows,

drive

-through service and carousel windows, and

vestibule.

§ 1250

Building or

Building

Component

–

39 Years

Window

Treatments

Window treatments such as drapes, curtains,

louvers, blinds, post construction tinting or interior

decorative theme

décor that are readily removable.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

164 | Page

A. Retail Industries

Field Directive on the Planning and Examination of Cost Segregation Issues in the

Retail Industry

December 16, 2004

MEMORANDUM FOR INDUSTRY DIRECTORS, LMSB

DIRECTORS, FIELD OPERATIONS, LMSB

DIRECTOR, FIELD SPECIALISTS, LMSB

DIRECTOR, PREFILING AND TECHNICAL GUIDANCE, LMSB

AREA DIRECTORS, SBSE

FROM: /s/ Henry V. Singleton

Industry Director, Retailers, Food, Pharmaceuticals & Healthcare

/s/ Steve Burgess

Director, Examination, SBSE

SUBJECT: Field Directive on the Planning and Examination of Cost Segregation Issues in the Retail

Industry

INTRODUCTION

This memorandum is intended to provide direction to effectively utilize resources in the classification and

examination of a taxpayer who is recovering costs through depreciation of tangible property used in the

operation of a retail business. This Directive is not an official pronouncement of the law or the position of the

Service and cannot be used, cited or relied upon as such.

BACKGROUND

The crux of cost segregation is determining whether an asset is I.R.C. §1245 property (shorter cost recovery

period property, 5 or 7 years) or §1250 property (longer cost recovery period property, 39, 31.5 or 15 years).

The most common example of §1245 property is depreciable personal property, such as equipment. The

most common examples of §1250 property are buildings and building components, which generally are not

§1245 property.

The difference in recovery periods has placed the Internal Revenue Service and taxpayers in adversarial

positions in determining whether an asset is §1245 or §1250 property. Frequently, this causes the excessive

expenditure of examination resources. The Director for the Retailers, Food, Pharmaceuticals and Healthcare

Industry chartered a working group to address the most efficient way to approach cost segregation issues

specific to the retail industry. The group produced the attached matrix and related definitions as a tool to

reduce unnecessary disputes and foster consistent audit treatment.

PLANNING AND EXAMINATION GUIDANCE

Attached Retail Exhibit A is a matrix recommending the categorization and general depreciation system

recovery period of various retail assets. (For recovery periods under IRC §168(g) alternative depreciation

I.R.C. §1245 can apply to certain qualified recovery nonresidential real estate placed in service after 1980

and before 1987. See I.R.C. §1245 (a) (5).

165 | Page

system, see Revenue Procedure 87-56, 1987-2 CB 674). If the taxpayer’s tax return position for these assets

is consistent with the recommendations in Retail Exhibit A, examiners should not make adjustments to

categorization and lives. If the taxpayer reports assets differently, then adjustments should be considered.

The Industry intends to update Retail Exhibit A regularly.

See also the Cost Segregation Audit Techniques Guide.

If you have any questions, please contact the Deductible and Capital Expenditures (DCE) Practice Network.

Attachments: Exhibit A

This matrix, which is part of the Cost Segregation Audit Techniques Guide, is intended to provide direction to

effectively utilize resources in the classification and examination of property used in the operation of a retail

business such as a department or grocery store. General fact patterns specific to this industry have been

considered in the classification of these assets and may not be applicable to other industries. Similarly, asset

classification guidance issued for other industries is based on the general fact pattern for that industry and

may not be applicable to a retail business situation. For example, for asset classification of restaurants

located within a retail store, refer to the industry directive for restaurants. For examination techniques and

historical background related to this issue, refer to the Cost Segregation Audit Techniques Guide.

NOTE: In the case of certain leasehold improvement property, the classifications in this directive are

superseded to the extent that the American Jobs Creation Act of 2004 modifies IRC Section 168. Thus, a 15-

year straight line recovery period should replace the recovery period shown in the following matrix if the asset

is “qualified leasehold improvement property" (as defined in IRC Section 168(e)(6)) placed in service by the

taxpayer after 10/22/04 and before 01/01/08.

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

Awnings &

Canopies

Readily removable overhang or covering, often of canvas

or plastic, used to provide shade or cover over a

storefront, window, or door; or used inside a structure to

identify a particular department or selling area. Examples

include applications

over an exterior door or window, or

attached to interior walls or suspended from ceilings for

bakery, deli, floral, meat, or produce departments. Also

includes canopies designed to protect customers and

gasoline fueling equipment from weather conditions an

to act as advertising displays that are anchored with bolts

and are not attached to buildings or other structures.

Does not include canopies that are an integral part of a

building’s structural shell, such as in the casino industry,

or over docks. See al

so Concrete Foundations &

Footings and Loading Docks.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Beverage

Equipment

Equipment for storage and preparation of beverages and

beverage delivery systems. Beverage equipment includes

the refrigerators, coolers, dispensing systems, and the

dedicated electrical, tubing or piping for such equipment.

The dispensing system may be gr

avity, pump or gas

driven. See also Refrigerated Structures.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Ceilings

Includes all interior ceilings regardless of finish or décor;

e.g. drywall or plaster ceilings, acoustic ceilings,

suspended cei

lings (including hangers, frames, grids and

tiles or panels), decorative metal or tin finishes, plastic

§ 1250

Building or

Bui

lding

Component

–

39 Years

166 | Page

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

panels, decorative panels, etc. See also Awnings &

Canopies, Millwork

- Decorative and Millwork -

General Building or Structural.

Computers

Processors (CPU), direct access storage device (DASD),

tape drives, desktop and laptop computers, CRT,

terminals, monitors, printers, and other peripheral

equipment. Excludes Point of Sale (POS) systems and

computers that are an integral part of other equipment

(e.g. fire detection, heating, cooling, or energy

management systems, etc.).

§ 1245

00.12

Information

Systems

–

5 Years

Concrete

Foundations

& Footings

Includes formwork, reinforcement, concrete block, and

pre

-cast or cast-in-place work related to foundations and

footings necessary for the proper setting of the building.

§ 1250

Building or

Building

Component

–

39 Years

Concrete

Foundations

& Footings

Foundations or footings for signs, light poles, and other

land improvements (except buildings).

§ 1250

00.3 Land

Improvements

–

15 Years

Concrete

Foundations

& Footings

The supporting concrete footings used to anchor gasoline

pump canopies are inherently permanent structures and

are classified a

s land improvements.

§ 1250

57.1

Distributive

Trades and

Services

–

15 years

Data

Handling

Equipment

Includes adding and accounting machines, calculators,

copiers, and duplicating machines. Excludes computers

and computer peripheral equipment, see

Computers.

§ 1245

00.13 Data

Handling

Equipment,

except

Computers

–

5 Years

Doors

Interior and exterior doors, regardless of decoration,

including but not limited to, double opening doors,

overhead doors, revolving doors, mall entrance security

gates, roll

-up or sliding wire mesh or steel grills and

gates, and door hardware (such as doorknobs, close

rs,

kick plates, hinges, locks, automatic openers, etc.).

§ 1250

Building or

Building

Component

–

39 Years

Doors

Special lightweight, double action doors installed to

prevent accidents in a heavily trafficked area. For

example, flexible doors, or

clear or strip curtains used

between stock and selling areas.

§ 1245

57.0

Distributive

Trades and

Services

–

5 Years

Doors - Air

Curtains

Air doors or curtains are air systems located above doors

and windows that circulate air to stabilize environments

and save energy by minimizing the heated/air conditioned

air loss through open doorways and windows. They also

effectively repel flying insects, dust, and pollutants.

§ 1250

Building or

Building

Component

–

39 Years

Drive-

Through

Equipment

Drive-through equipment includes order taking,

merchandise delivery, and payment processing systems

whether mechanical or electronic. Excludes building

§ 1245

57.0

Distributive

167 | Page

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

elements such as doors, bays, or windows. See also

Walls

– Exterior, and Windows for drive-through bays

and windows.

Trades and

Services

5 Years

Electrical

Includes all components of the building electrical system

used in the operation or maintenance of the building or

necessary to provide general building services such as

elect

rical outlets of general applicability and accessibility,

lighting, heating, ventilation, air conditioning, and

electrical wiring.

§ 1250

Building or

Building

Component

–

39 Years

Electrical

Special electrical connections which are necessary to and

used directly with a specific item of machinery or

equipment or connections between specific items of

individual machinery or equipment; such as dedicated

electrical outlets, wiring, conduit, and circuit breakers by

which machinery and equipment is connect

ed to the

electrical distribution system. Does not include electrical

outlets of general applicability and accessibility. See

Chapter 5 of the Cost Segregation Audit Techniques

Guide for allocation examples.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Elevators

and

Escalators

Elevators and escalators, which include handrails and

smoke baffles, are permanently affixed to the building and

intended to remain in place. They relate to the operation

or maintenance of the building and are

structural

components.

§ 1250

Building or

Building

Component

–

39 Years

Energy

Management

Systems

Energy management systems control all energy-using

systems in a building, automatically checking occupancy

schedules, reading temperatures, and

re-circuiting light

levels, causing all heating, cooling and lighting equipment

to operate so as to minimize energy costs. Includes, for

example, detection devices such as smoke, motion and

infrared devices, photocells, foil and contact switches,

pressure

switches, proximity alarms, sensors, alarm

transmitting controls, data gathering panels, demand

controllers, thermostats, computer controls, outside air

economizers, occupancy sensors, electronic ballasts, and

all related wiring and conduit. May also provi

de for fire

and burglary protection.

§ 1250

Building or

Building

Component

–

39 Years

Exit Signs

Signs posted along exit routes that indicate the direction

of travel to the nearest exit. These signs typically read

"EXIT" and may have distinctive colors, i

llumination, or

arrows indicating the direction to the exit.

§ 1250

Building or

Building

Component

–

39 Years

Fire

Protection &

Alarm

Systems

Includes sensing devices, computer controls, sprinkler

heads, piping or plumbing, pumps, visual and

audible

alarms, alarm control panels, heat and smoke detection

devices, fire escapes, fire doors, emergency exit lighting

and signage, and wall mounted fire extinguishers

necessary for the protection of the building.

§ 1250

Building or

Building

Component

–

39 Years

168 | Page

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

Fire

Protection

Equipment

Includes special fire detection or suppression systems

directly associated with a piece of equipment. For

example, a fire extinguisher designed and used for

protection against a particular hazard created by the

business activity.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Floor

Coverings

Floor covering affixed with permanent adhesive, nailed, or

screwed in place. Examples include ceramic or quarry

tile, marble, paving brick, and other coverings

cemented,

mudded, or grouted to the floor; epoxy or sealers; and

wood flooring.

§ 1250

Building or

Building

Component

–

39 Years

Floor

Coverings

Floor covering that is installed by means of strippable

adhesives. For the retail industry, all vinyl composition tile

(VCT), sheet vinyl, and carpeting will be treated as not

permanently attached and not intended to be permanent.

Also includes flooring that is frequently moved and reused

to create a department theme or seasonal display.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Floors

Includes concrete slabs and other floor systems. Floors

include special treatments applied to or otherwise a

permanent part of the floor. For example, "superflat"

finish, sloped drainage basins, raised p

erimeter, serving

line curb, or cooler, freezer and garbage room floors.

§ 1250

Building or

Building

Component

–

39 Years

Heating,

Ventilating &

Air

Conditioning

(HVAC)

Includes all components of a central heating, ventilating

and air

conditioning system not specifically identified

elsewhere. HVAC systems that are installed not only to

meet the temperature and humidity requirements of

machinery, but are also installed for additional significant

purposes, such as customer comfort and ven

tilation, are

building components.

§ 1250

Building or

Building

Component

–

39 Years

Heating,

Ventilating &

Air

Conditioning

(HVAC)

Only separate HVAC units that meet the sole justification

test are included (i.e., machinery the sole justification for

the

installation of which is the fact that such machinery is

required to meet temperature or humidity requirements

which are essential for the operation of other machinery

or the processing of materials or foodstuffs.) HVAC may

meet the sole justification test

even though it incidentally

provides for the comfort of employees, or serves, to an

insubstantial degree, areas where such temperature or

humidity requirements are not essential. Includes

refrigeration units, condensers, compressors,

accumulators, coolers

, pumps, connecting pipes, and

wiring for the mechanical equipment for climate controlled

rooms, walk

-in freezers, coolers, humidors and ripening

rooms. Allocation of HVAC is not appropriate. See also

Refrigerated Structures, Refrigeration Equipment,

and

Ripening Rooms.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Kiosks

A small retail outlet, often prefabricated, which acts like a

fixed retail outlet yet is not permanent. Kiosks may be

used to retail merchandise such as newspapers and

magazines, film and digital images, and food and

§ 1245

57.0

Distributive

Trades and

Services -

169 | Page

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

beverages. Kiosks are also present in shopping centers

or malls where they function as temporary or portable

retail outlets for a variety of merchandise.

5 Years

Light

Fixtures –

Interior

Includes lighting such as recessed and lay-in lighting,

night lighting, and exit lighting, as well as decorative

lighting fixtures that provide substantially all the artificial

illumination in the building or along building walkways. For

emergency and exit

lighting, see Fire Protection &

Alarm Systems.

§ 1250

Building or

Building

Component

–

39 Years

Light

Fixtures –

Interior

Decorative light fixtures are light fixtures, such as neon

lights or track lighting, which are decorative in nature and

not necessary for the operation of the building. In other

words, if the decorative lighting were turned off, the other

sources of lighti

ng would provide sufficient light for

operation of the building. If the decorative lighting is the

primary source of lighting, then it is section 1250 property.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Light

Fixtures -

Exterior

Exterior lighting whether decorative or not is considered

section 1250 property to the extent that the lighting

relates to the maintenance or operation of the building.

This category includes building mounted lighting to

illuminate walkways, entrances, parking, etc.

§ 1250

Building or

Building

Component

–

39 Years

Light

Fixtures -

Exterior

Pole mounted or freestanding outdoor lighting system to

illuminate sidewalks, parking or recreation areas. See

also

Poles & Pylons. Note* asset class 00.3 Land

improvements includes both section 1245 and 1250

property per Rev. Proc. 87-56.

See Note*

00.3 Land

Improvements

–

15 Years

Light

Fixtures -

Exterior

Plant grow lights or lighting that highlights only the

landscaping or building exterior (but not parking areas or

walkways) does not relate to the maintenance or

operation of the building

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Docks

Includes bumpers, permanently installed dock levelers,

plates, seals, lights, canopies, and overhead doors used

in the receiving and shipping of merchandise.

§ 1250

Building or

Building

Component

–

39 Years

Docks

Includes items such as compactors, conveyors, hoists

and balers.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Millwork -

Decorative

Decorative millwork is the decorative finish carpentry in a

retail selling area. Examples include detailed crown

moldings, lattice work placed over finished walls or

ceilings, cabinets, cashwraps, counters and toppers. The

decorative millwork serves to enh

ance the overall décor

of the retail store and is not related to the operation of the

building. Cabinets and counters in a restroom are

§ 1245

57.0

Distributive

Trades and

Services

5 Years

170 | Page

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

excluded from this category; see Restroom

Accessories.

Millwork -

General

Building or

Structural

General millwork is all building materials made of finished

wood (e.g., doors and frames, window frames, sashes,

porch work, mantels, panel work, stairways, and special

woodwork). Includes pre

-built wooden items brought to

the site for installation and items constructed on site such

as restroom cabinets, door jambs, moldings, trim, etc.

§ 1250

Building or

Building

Component

–

39 Years

Office

Furnishings

Includes desk, chair, credenza, file cabinet, table or other

urniture such as workstations. Also includes telephone

equipment, fax machines, and other communications

equipment. Does not include communications equipment

included in other asset classes in Rev. Proc. 87-56.

§ 1245

00.11 Office

Furniture,

Fixtures, and

Equipment

–

7 Years

Parking

Lots

Grade level surface parking area usually constructed of

asphalt, brick, concrete, stone or similar material.

Category includes bumper blocks, curb cuts, curb work,

striping, landscape islands, perimeter fences, and

sidewalks.

§ 1250

00.3 Land

Improvements

–

15 Years

Parking

Structures

Any structure or edifice the purpose of which is to provide

parking space. Includes, for example, garages, parking

ramps, or other parking structures.

§ 1250

Building or

Building

Component

–

39 Years

Plumbing

All piping, drains, sprinkler mains, valves, sprinkler heads,

water flow switches, restroom plumbing fixtures (e.g.

toilets) and piping, kitchen hand sinks, electric water

coolers, and all other components of a build

ing plumbing

system (water or gas) not specifically identified

elsewhere.

§ 1250

Building or

Building

Component

–

39 Years

Plumbing

Includes water, gas, or refrigerant hook-ups directly

connected to appliances or equipment, eyewash stations,

kitchen drainage, and kitchen hot water heater. For

example, a hair salon in a retail outlet would require

special hair washing sinks and water hook

-up for the

sinks.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Point of Sale

(POS)

Systems

A register or terminal based data collection system used

to control and record all sales (cash, charge, COD, gift

cards, layaway, etc.) at the point of sale. Includes cash

registers, computerized sales systems and related

peripheral equipment, satellite syste

ms, scanners, and

wands. See also Electrical for hook-ups.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Poles &

Pylons

Light poles for parking areas and other poles poured in

concrete footings or bolt

-mounted for signage, flags, etc.

Note*

asset class 00.3 Land improvements includes both

section 1245 and 1250 property per Rev. Proc. 87

-56.

See also Signs and Light Fixtures – Exterior.

See Note*

00.3 Land

Improvements

–

15 Years

Refrigeration

Equipment

Includes refrigeration units, condensers, compressors,

accumulators, coolers, pumps, connecting pipes, and

associated wiring. Refrigeration equipment is commonly

§ 1245

57.0

Distributive

171 | Page

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

found in climate controlled rooms, walk-in freezers,

coolers, humidors, and ripening rooms.

Trades and

Services

5 Years

Refrigerated

Structures

Includes structural components such as walls, floors,

ceilings, and insulation to construct a climate controlled

structure, room or facility such as a cold storage

warehouse, walk

-in freezer, cooler, garbage room, or

humidor. See also Refrigeration Equipment.

§ 1250

Building or

Building

Component

–

39 Years

Refrigerated

Structures

A portable structure installed inside the building,

consisting of prefabricated panels mounted on a movable

framework. Portable structures are designed to be able to

be disassembled and moved. See also

Refrigeration

Equipment.

§ 1245

57.0

Distributive

Trad

es and

Services

5 Years

Restaurant –

In Store

See Restaurant Industry Directive. For retail situations

that include a restaurant or other food preparation

property within a store, such as a deli or snack bar, the

facts are similar to those considered

in the industry

directive on restaurants and that directive may be relied

upon for asset classification.

Restroom

Accessories

Includes paper towel dispensers, electric hand dryers,

towel racks or holders, cup dispensers, purse shelves,

toilet

paper holders, soap dispensers or holders, lotion

dispensers, sanitary napkin dispensers and waste

receptacles, coat hooks, handrails, grab bars, mirrors,

shelves, vanity cabinets, counters, ashtrays, baby

changing stations, and other items generally found

public restrooms that are built into or mounted on walls or

partitions.

§ 1250

Building or

Building

Component

–

39 Years

Restroom

Partitions

Includes shop made and standard manufacture toilet

partitions, typically metal, but may be plastic or other

terials.

§ 1250

Building or

Building

Component

–

39 Years

Retail

Accessories

Accessories used to better display merchandise that are

not held for sale. Includes assets such as audio/video

display devices, artwork (if depreciable), holiday

decorations, lamps, mirrors, pictures, plaques, potted

plants, and decorative mobile props (such as coat of

arms, sporting equipment or memorabilia, etc., excluding

non-depreciable art, antiques or collectibles).

§ 1245

57.0

Distributive

Trades and

Service

s --

5 Years

Retail

Conveying

Equipment

Includes assets such as belt or roller conveyors and

pneumatic tube systems used to distribute retail

merchandise.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Retail

Equipment

Includes assets such as sewing machines, tackers,

ironing equipment, pressing tables, steam presses,

pinning machines, price mark guns, marking machines,

work benches, power tools, check writers, endorsing

§ 1245

57.0

Distributive

Trades and

Services --

172 | Page

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

machines, paper cutters, perforators, postage meters,

money sorters, co

in counting and dispensing equipment,

and shopping carts.

5 Years

Retail

Fixtures

Includes assets such as back cases or islands, cabinets,

cubes, deli cases, end caps, floor stands, garment racks,

gondolas,

grid systems, mannequins, refrigerator/freezer

cases, shelving, sign holders or stands, show cases, wall

display units and other retail fixtures (such as dressing or

fitting room partitions) needed in the business operation

that are not a building component.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Retail

Furniture

Includes furniture unique to retail stores and

distinguishable from office furniture. For example, a high

stool in a cosmetic department, a shoe department

footstool, a hair salon barber chair, or a bench outside a

dressing room. See also Office Furnishings.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Ripening

Rooms

Special enclosed equipment boxes used to ripen produce

by circulating special gases. The rooms are large boxes

with special doors and large airplane

-type propellers,

which circulat

e the gases used to ripen the produce. The

boxes are housed within a distribution center warehouse.

These specialized facilities are considered to be part of

the retail distribution equipment because they have a

special retail purpose and cannot be used fo

r any other

purpose. The boxes are not a part of the building

structure.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Roof

All elements of the roof including but not limited to joists,

rafters, deck, shingles, vapor barrier,

skylights, trusses,

girders, and gutters. Determination of whether decorative

elements of a roof (e.g. false dormers, mansard)

constitute structural building components depends on

their integration with the overall roof, not their load

bearing capacity. If

removal of the decorative element

results in the direct exposure of building components to

water, snow, wind, or moisture damage, or if the

decorative element houses lighting fixtures, wiring, or

other structural components, then the decorative

elements a

re part of the overall roof system and are

structural components of the building.

§ 1250

Building or

Building

Component

–

39 Years

Security

Systems

Includes security equipment for the protection of the

building (and its contents) from burglary or vandalism and

protection of employees from assault. Examples include

window and door locks; card key access systems; keyless

entry systems; security cameras, recorders, monitors and

related equipment; perimeter and interior building motion

detectors; security ligh

ting; alarm systems; and security

system wiring and conduit.

§ 1250

Building or

Building

Component

39 Years

Security

Systems

Electronic article surveillance systems including electronic

gates, surveillance cameras, recorders, monitors and

related equipment, the primary purpose of which is to

§ 1245

57.0

Distributive

173 | Page

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

minimize merchandise shrinkage due to theft. Also

includes teller

-style pass-through windows, security

booths, and bulletproof enclosures generally located in

the cash office and customer service areas.

Trades and

Services

5 Years

Signs

Exit signs, restroom identifiers, room numbers, and other

signs relating to the operation or maintenance of a

building.

§ 1250

Building or

Building

Component

–

39 Years

Signs

Interior and exterior signs used for display or theme

identity. For example, interior signs to identify

departments or exterior signs to display trade names or

trade symbols.

For pylon signs, includes only sign face. See also Poles

& Pylons.

§ 1245

57.0

istributive

Trades and

Services

5 Years

Site

Preparation,

Grading &

Excavation

In general, land preparation costs include the one-time

cost of clearing and grubbing, site stripping, fill or

excavation, and grading to allow development of land.

Clearing and grubbing is the removal of debris, brush,

trees, etc. from the site. Stripping is the removal of the

topsoil to provide a stable surface for site and building

improvements. The grading of land involves moving soil

for the purpose of producing a more level surface to allow

development of the land.

Land

Site

Preparation,

Grading &

Excavation

Clearing, grading, excavating and removal costs directly

associated with the construction of buildings and building

components are part of the cost of

construction of the

building and depreciated over the life of the building.

§ 1250

Building or

Building

Component

–

39 Years

Site

Preparation,

Grading &

Excavation

Clearing, grading, excavating and removal costs directly

associated with the

construction of sidewalks, parking

areas, roadways and other depreciable land

improvements are part of the cost of construction of the

improvements and depreciated over the life of the

associated asset.

§ 1250

00.3 Land

Improvements

–

15 Years

Site Utilities

Site utilities are the systems that are used to distribute

utility services from the property line to the retail building.

Includes water, sanitary sewer, gas and electrical

services.

§ 1250

Building or

Building

Component

–

39 Years

Site Work

Site work includes curbing, paving, general site

improvements, fencing, landscaping, roads, sewers,

sidewalks, site drainage and all other site improvements

not directly related to the building. For sanitary sewers,

see Site Utilities.

§ 1250

00.3 Land

Improvements

–

15 Years

Sound

Systems

Equipment and apparatus, including wiring, used to

provide amplified sound or music. For example, public

address by way of paging a customer or background

music. Excludes applications linked to fire protection and

alarm systems.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

174 | Page

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

Trash

Enclosures

Enclosures for waste receptacles that are attached to the

building. Typically constructed of the same materials as

the building shell with either interior or

exterior access.

These trash enclosures are an integral part of the building

shell and cannot be moved without damage to the

underlying building.

§ 1250

Building or

Building

Component

–

39 Years

Trash

Enclosures

Freestanding enclosures for waste receptacles, typically

constructed on a concrete pad with its posts set in the

concrete. Serves both safety and decorative functions.

§ 1250

00.3 Land

Improvements

–

15 Years

Wall

Coverings

Includes interior and exterior paint; ceramic or quarry tile,

marble, stone, brick and other finishes affixed with mortar,

cement or grout; paneling, wainscoting and other wood

finishes affixed with nails, screws or permanent

adhesives; and sanitary kitchen wall panels such as

fiberglass, stainless steel and plastic wall panels.

§ 1250

Building or

Building

Component

–

39 Years

Wall

Coverings

Strippable wallpaper that causes no damage to the

underlying wall or wall surface.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Walls –

Exterior

Includes all exterior walls and building support regardless

of construction materials. Exterior walls may include

columns, posts, beams, girders, curtain walls, tilt up

panels, studs, framing, sheetrock, insulation, windows,

doors, exterior façade, brick, masonry, etc.

Also includes

drive-through bay, windows, and doors.

§ 1250

Building or

Building

Component

–

39 Years

Walls –

Interior

Partitions

Includes all load bearing interior partitions regardless of

construction. Also includes non

-load bearing partitions

regardless of height (typically constructed of studs and

sheetrock or other materials) that divide or create rooms

or provide traffic control. Includes rough carpentry and

plaster, dry wall or gypsum board, and other finishes.

§ 1250

Building or

Building

Component

–

39 Years

Walls –

Interior

Partitions

Interior walls for merchandise display where the partition

can be 1) readily removed and remain in substantially the

same condition after removal as before, or 2) moved and

reused, stored, or

sold in their entirety.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Windows

Exterior windows, including store front windows, drive-

through service and carousel windows, and vestibule.

§ 1250

Building or

Building

Component

–

39 Years

Window

Treatments

Window treatments such as drapes, curtains, louver,

blinds, post construction tinting and interior decorative

theme décor which are readily removable.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

175 | Page

D. Pharmaceutical and Biotechnology

Field Directive on the Planning and Examination of Cost Segregation Issues in the

Biotech/Pharmaceutical Industry

November 28, 2005

MEMORANDUM FOR INDUSTRY DIRECTORS, LMSB

DIRECTORS, FIELD OPERATIONS, LMSB

DIRECTOR, FIELD SPECIALISTS, LMSB

DIRECTOR, PREFILING AND TECHNICAL GUIDANCE, LMSB

AREA DIRECTORS, SBSE

FROM: /s/ Henry V. Singleton

Industry Director, Retailers, Food, Pharmaceuticals & Healthcare

/s/ Steve Burgess

Director, Examination, SBSE

SUBJECT: Field Directive on the Planning and Examination of Cost Segregation Issues in the

Biotech/Pharmaceutical Industry

INTRODUCTION

This memorandum is intended to provide direction to effectively utilize resources in the classification and

examination of a taxpayer who is recovering costs through depreciation of tangible property used in the

Biotech/Pharmaceutical Industry. This Directive is not an official pronouncement of the law or the position of

the Service and cannot be used, cited or relied upon as such.

BACKGROUND

The crux of cost segregation is determining whether an asset is I.R.C. §1245 property (shorter cost recovery

period property) or §1250 property (longer cost recovery period property). The most common example of

§1245 property is depreciable personal property, such as equipment. The most common examples of §1250

property are buildings and building components, which generally are not §1245 property.

The difference in recovery periods has placed the Internal Revenue Service and taxpayers in adversarial

positions in determining whether an asset is §1245 or §1250 property. Frequently, this causes the excessive

expenditure of examination resources. The Director for the Retailers, Food, Pharmaceuticals and Healthcare

Industry chartered a working group to address the most efficient way to approach cost segregation issues

specific to the Biotech/Pharmaceutical industry. The group produced the attached matrix and related

definitions as a tool to reduce unnecessary disputes and foster consistent audit treatment.

PLANNING AND EXAMINATION GUIDANCE

The Biotech/Pharmaceutical industry matrix recommending the categorization and general depreciation

system recovery period of various assets is attached as Exhibit A. (For recovery periods under IRC §168(g)

alternative depreciation system, see Revenue Procedure 87-56, 1987-2 CB 674). If the taxpayer’s tax return

position for these assets is consistent with the recommendations in Biotech/Pharmaceutical matrix (Exhibit A),

examiners should not make adjustments to categorization and recovery periods. If the taxpayer reports assets

differently, then adjustments should be considered. The Industry intends to update the

Biotech/Pharmaceutical matrix (Exhibit A) regularly.

176 | Page

See also the Cost Segregation Audit Techniques Guide. Refer especially to Appendix Chapter 6.3, which

provides examples and general rules for asset classification.

If you have any questions, please contact the Deductible and Capital Expenditures (DCE) Practice Network.

LMSB DIRECTIVE ON COST SEGREGATION IN THE BIOTECH /PHARMACEUTICAL

INDUSTRY

EXHIBIT A

This matrix, which is part of the Cost Segregation Audit Techniques Guide, is intended to provide direction to

effectively utilize resources in the classification and examination of property used in the

Biotech/Pharmaceutical industry. General fact patterns specific to this industry have been considered in the

classification of these assets and may not be applicable to other industries. Similarly, asset classification

guidance issued for other industries is based on the general fact pattern for that industry and may not be

applicable to the Biotech/Pharmaceutical industry. For example, for asset classification of restaurants located

within a pharmaceutical manufacturing plant, refer to the industry directive for restaurants. For examination

techniques and historical background related to this issue, refer to the Cost Segregation Audit Techniques

Guide.

CAUTION: In the case of certain leasehold improvement property, the classifications in this directive are

superseded to the extent that the American Jobs Creation Act of 2004 modifies IRC Section 168. Thus, a 15-

year straight line recovery period should replace the recovery period shown in the following matrix if the asset

is “qualified leasehold improvement property" (as defined in IRC Section 168(e)(6)) placed in service by the

taxpayer after 10/22/04 and before 1/1/08.

ASSET

PROPERTY

TYPE

DESCRIPTION

RECOVERY

PERIOD

Awnings &

Canopies

1245

Readily removable overhangs or coverings, often of

canvas or plastic, used to provide shade or cover

over exterior doors or windows. Does not include

canopies that are an integral part of a building’s

structural sh

ell, such as in the casino industry or

over docks. See also Concrete Foundations &

Footings and Loading Docks.

Personal

Property with

No Class Life -

7 Years

Breakrooms /

Pantries /

Lunchrooms

1250

A space within the building used for employee

breaks, lunches, etc.

Building or

Building

Component –

39 Years

Breakrooms /

Pantries /

Lunchrooms

1245

Equipment such as tables, chairs, dishwashers,

stoves, ovens, microwaves, toasters, coffee

machines, refrigerators, and freezers.

Personal

Property with

No Class Life -

7 Years

Bridges &

Tunnels

1250 / 1245

Depreciable improvements directly to or added to

land, whether such improvements are section 1245

or 1250. Includes bridges and tunnels and all

construction required for their completion (such as

exc

avation, backfill, footings, foundations, piers,

stone base, paving, etc.).

00.3 - Land

Improvements

but see Note 2

for exceptions

Ceilings

1250

All interior ceilings regardless of finish or décor; e.g.,

drywall or plaster, acoustic, suspended, (including

Building or

Building

177 | Page

ASSET

PROPERTY

TYPE

DESCRIPTION

RECOVERY

PERIOD

hangers, frames, grids, and tiles or panels),

decorative metal or tin, plastic or decorative panels,

clouds, etc. See also Clean Room / Climate

Controlled Areas.

Component –

39 Years

Clean Room /

Climate

Controlled

Areas

1250

Areas created by fully enclosed walls, floors,

ceilings, wall and floor coverings, doors, and

windows. These are designed to remain in place

indefinitely, require substantial time and effort to

construct or remove, and integrated into the

building's de

sign. These areas are climate

controlled for air cleanliness, or temperature or

humidity. See also HVAC, Electrical, Plumbing, Gas

& Sewer, Ceilings, Floors, Walls, Windows, Doors,

Wall Coverings, and Floor Coverings.

Building or

Building

Component –

39 Years

Clean Room /

Climate

Controlled

Areas –

Special

Equipment

1245

Special items installed to achieve a controlled

environment (air cleanliness, temperature, or

humidity) and to operate the facilities in a clean

room / climate controlled area (such as

special

variable power outlets; electric power, air, and

vacuum lines; duct work; special air handling units

and HEPA filters; refrigeration units, steam boilers,

and temperature controls). Does not include building

systems used in the operation or mainten

ance of

the building or necessary to provide general building

services.

Personal

Property -

Note 1

Computers

1245

Processors (CPU), direct access storage device

(DASD), tape drives, desktop and laptop computers,

CRT, terminals, monitors, printers, and o

ther

peripheral equipment. Excludes process equipment

control systems and computers that are an integral

part of building structural components (e.g., fire

detection, heating, cooling, or energy management

systems, etc.).

00.12

Information

Systems – 5

Years

Concrete

1250

Foundations & Footings Foundations and footings

necessary for the proper setting of the building.

Excavation and backfill for building foundations.

Excavation and backfill for special equipment

foundations where contained within the

footprint of

the building. Includes formwork, reinforcement,

concrete block, and pre-cast or cast-in-place work.

Building or

Building

Component –

39 Years

Concrete

Foundations &

Footings

1250

Foundations and footings for signs, light poles, and

other la

nd improvements (except buildings).

Includes excavation, backfill, formwork,

reinforcement, concrete block, and pre

-cast or cast-

in-place work.

00.3 - Land

Improvements

but see Note 2

for exceptions

Concrete

Foundations &

Footings

1245

A foundation, pad, or footing for machinery or

equipment that is so specially designed that it is in

essence a part of the machinery or equipment. Any

Personal

Property -

Note 1

178 | Page

ASSET

PROPERTY

TYPE

DESCRIPTION

RECOVERY

PERIOD

function as a building component must be strictly

incidental to the function as an essential part of the

em of machinery or equipment that necessitated

the special design of the foundation. Increased

thickness alone is not sufficient to show that the

foundation, pad, or footing is so specially designed

that it is in essence a part of the machinery or

equipmen

t it supports. Excavation and backfill are

not included where the foundation, pad, or footing is

contained within the footprint of the building.

Includes formwork, reinforcement, concrete block,

and pre-cast or cast-in-place work.

Data Handling

Equipment

1245

Adding and accounting machines, calculators,

copiers, and duplicating machines. Excludes

computers and computer peripheral equipment. See

also Computers.

00.13 Data

Handling

Equipment,

except

Computers – 5

Years

Doors

1250

Interior and exterior doors, regardless of decoration

(including but not limited to, double opening doors,

overhead doors, revolving doors, entrance security

gates, or fire doors) and associated hardware (such

as doorknobs, closers, kick plates, hinge

s, locks,

automatic openers, etc.).

Building or

Building

Component –

39 Years

Electrical

1250

All components of a building's or other inherently

permanent structure's electrical distribution

system(s) used in the operation or maintenance of

the building or necessary to provide general building

services (such as lighting, heating, ventilation, air

onditioning, etc.), electrical outlets of general

applicability and accessibility, and electrical wiring.

Building or

Building

Component –

39 Years

Electrical

1245

Special electrical connections which are necessary

to and used directly with a

specific item of

machinery or equipment or connections between

specific items of individual machinery or equipment;

such as dedicated electrical outlets, wiring, conduit,

and circuit breakers by which machinery and

equipment is connected to the building's

or other

inherently permanent structure's electrical

distribution system(s). Does not include electrical

outlets of general applicability and accessibility. See

Chapter 5 of the Cost Segregation Audit Techniques

Guide for allocation examples.

Personal

Property -

Note 1

Electrical –

Light Fixtures -

Exterior

1250

Exterior lighting whether decorative or not is

considered section 1250 property to the extent that

the lighting relates to the operation or maintenance

of the building. This category includes building

Building or

Building

Component –

39 Years

179 | Page

ASSET

PROPERTY

TYPE

DESCRIPTION

RECOVERY

PERIOD

mounted lighting to illuminate walkways, entrances,

parking, etc.

Electrical –

Light Fixtures -

Exterior

1245

Lighting that highlights only the landscaping or

building exterior (but not parking areas or walkways)

and does not relate to the operation or maintenance

of the building.

Personal

Property with

No Class Life -

7 Years

Electrical –

Light Fixtures -

Exterior

1250 / 1245

Pole mounted or freestanding outdoor lighting

system to illuminate sidewalks, parking or recreation

areas See also, Poles & Pylons

00.3 - Land

Improvements

but see Note 2

for exceptions

Electrical –

Light Fixtures -

Interior

1250

Includes lighting such as recessed and lay-in

lighting, night lighting, and exi

t lighting, as well as

decorative lighting fixtures that provide substantially

all the artificial illumination in the building or along

building walkways. For emergency and exit lighting,

see Fire Protection & Alarm Systems.

Building or

Building

Component –

39 Years

Electrical –

Light Fixtures -

Interior

1245

Light fixtures, such as neon, track lighting, or grow

lights which are decorative in nature and not

necessary for the operation or maintenance of the

building. If the decorative lighting were

turned off,

the other sources of lighting would provide sufficient

light for operation or maintenance of the building. If

the decorative lighting is the primary source of

lighting, then it is section 1250 property.

Personal

Property with

No Class Life -

7 Years

Electrical –

Light Fixtures -

Special Use

1245

Special light fixtures which are necessary to and

used directly with a specific item of machinery or

equipment, manufacturing process, or research and

experimentation activity. Does not

include light

fixtures that relate to the operation or maintenance

of the building.

Personal

Property -

Note 1

Elevators &

Escalators

1250

Elevators and escalators, including all components

thereof (e.g., handrails and smoke baffles), which

are

permanently affixed to the building and

designed to remain in place. They relate to the

operation or maintenance of the building and are

structural components.

Building or

Building

Component –

39 Years

Energy

Management

Systems

1250

Energy management systems to monitor or

maximize the efficiency of building systems (such as

HVAC, lighting, fire protection and security systems)

by starting and stopping the systems, raising and

lowering temperatures, regulating dampers and

valves, adjus

ting lighting levels, alerting employees

to problems, etc. Includes detection devices such as

smoke, motion, and infrared devices, photocells, foil

and contact switches, pressure switches, proximity

alarms, sensors, alarm transmitting controls, data

gathering panels, demand controllers, thermostats,

Building or

Building

Component –

39 Years

180 | Page

ASSET

PROPERTY

TYPE

DESCRIPTION

RECOVERY

PERIOD

computer controls, outside air economizers,

occupancy sensors, electronic ballasts, and all

related wiring and conduit.

Energy

Management

Systems

1245

Energy management systems to monitor or

maximize the efficiency of non

-building systems by

starting and stopping process equipment, regulating

equipment air handlers, detecting chemical leaks or

equipment operating temperatures, monitoring

power quality, etc. Includes s

ensors, alarm

transmitting controls, data gathering panels,

demand controllers, thermostats, computer controls,

outside air economizers, and related wiring and

conduit for the non

-building energy management

system.

Personal

Property -

Note 1

Fencing,

Retaining Walls,

Screen Walls,

Fountains &

Other Land

Improvements

1250 / 1245

Depreciable improvements directly to or added to

land, whether such improvements are section 1245

or 1250 property. Examples include fences; canals;

waterways; drainage facilities; sewers (not including

municipal sewers in Class 51); retaining walls; water

falls, and fountains; holding, settling, or detention

ponds; and irrigation systems.

00.3 - Land

Improvements

but see Note 2

for exceptions

Fire Protection

& Alarm

Systems

1250

Fire protection and alarm systems for the protection

of the building. Includes sensing devices, computer

controls, sprinkler heads, associated piping or

plumbing, pumps, visual and audible alarms, alarm

control panels, heat and smoke detec

tion devices,

fire escapes, fire doors, emergency exit lighting and

signage, and cabinets (regardless of mounting)

holding fire

-fighting equipment such as fire

extinguishers, fire hoses, etc.

Building or

Building

Component –

39 Years

Fire Protection

Equipment

1245

Special fire detection or suppression systems (such

as Halon or Carbon Dioxide, etc.) directly

associated with a piece of equipment or process.

Fire extinguishers and related fire extinguisher

cabinets designed and used for prot

ection against a

particular hazard created by a business activity. See

Restaurant Industry Directive for restaurants,

cafeterias, or other commercial food preparation

areas.

Personal

Property -

Note 1

Floor

Coverings

1250

Floor covering affixed with permanent adhesive,

nailed, or screwed in place. Includes marble, paving

brick, ceramic or quarry tile, and other coverings

cemented, mudded, or grouted to the floor; vinyl

composition tile (VCT), sheet vinyl, carpeting, or

wood attached with permanent adhe

sive, nails, or

screws; and paint, epoxy, coatings and sealers

directly applied to the floor.

Building or

Building

Component –

39 Years

181 | Page

ASSET

PROPERTY

TYPE

DESCRIPTION

RECOVERY

PERIOD

Floor Coverings

1245

Floor covering that is installed by means of

strippable adhesives and can be 1) readily

removed

and remain in substantially the same condition after

removal as before, or 2) moved and reused, stored,

or sold in its entirety.

Personal

Property -

Note 1

Floors

1250

Includes concrete slabs and other floor systems.

Floors include special

treatments applied to or

otherwise a permanent part of the floor. For

example, "super

flat" finish, sloped drainage basins,

raised perimeter, cooler, freezer and garbage room

floors. Does not include special foundations

- see

Concrete Foundations & Footings.

Building or

Building

Component –

39 Years

Floors

1245

Raised false floors located in a limited area and

installed over an existing floor to accommodate

specific equipment. Such floors are a necessary

part of the installation and operation of

the specific

equipment they accommodate. Removal of these

floors does not result in extensive renovations or

loss of functionality within the building.

Personal

Property -

Note 1

Gas & Sewer

1250

All components of a building's or other inherently

permanent structure's natural gas distribution

system and sewer collection system used in the

operation or maintenance of the building or

necessary to provide general building services, e.g.,

hot water and hot air (natural gas) and waste

removal (sewer).

Building or

Building

Component –

39 Years

Gas & Sewer

1245

Special natural gas and sewer connections which

are necessary to and used directly with a specific

item of machinery or equipment or connections

between specific items of individu

al machinery or

equipment. Includes dedicated piping, valves, and

hook

-ups by which machinery and equipment are

connected to the building's or other inherently

permanent structure's natural gas distribution

system(s) or sewer collection system(s). Does not

include natural gas or sewer connections of general

applicability and accessibility.

Personal

Property -

Note 1

Gas & Sewer -

Special Gas

Systems

1245

Special gas systems separate from the building's or

other inherently permanent structure's natural gas

system which are used in a manufacturing process

or research and experimentation activity. Special

gas would include carbon dioxide, pure oxygen,

nitroge

n, argon, etc. Includes filters, tanks, pumps,

specialized piping, valves, and end use

connections.

Personal

Property -

Note 1

Gas & Sewer -

Special Waste

Systems

1245

Special waste or sewer systems separate from the

building's or other inherently pe

rmanent structure's

sewer collection system which are used in a

Personal

Property -

Note 1

182 | Page

ASSET

PROPERTY

TYPE

DESCRIPTION

RECOVERY

PERIOD

manufacturing process or research and

experimentation activity. Special waste would

include toxic, bio

-hazard, nuclear, and medical.

Includes filters, tanks, pumps, specialized piping

and valves.

Heating,

Ventilating, Air

Conditioning

(HVAC)

1250

All components of a building's or other inherently

permanent structure's central heating, ventilating

and air conditioning distribution system(s) used in

the

operation or maintenance of the building or

necessary to provide general building services such

as forced cool and hot air, ventilation, ductwork, air

handlers, exchangers, baffles. HVAC systems that

are installed not only to meet the temperature and

humid

ity requirements of machinery, but are also

installed for additional significant purposes, such as

employee comfort and ventilation, are building

components.

Building or

Building

Component –

39 Years

Heating,

Ventilating, Air

Conditioning

(HVAC)

1245

Special and separate HVAC units that meet the sole

justification test are included (i.e., machinery the

sole justification for the installation of which is the

fact that such machinery is required to meet

temperature or humidity requirements which are

esse

ntial for the operation of other machinery or the

processing of materials or used in connection with

research or experimentation). HVAC may meet the

sole justification test even though it incidentally

provides for the comfort of employees, or serves, to

insubstantial degree, areas where such

temperature or humidity requirements are not

essential. Includes refrigeration units, condensers,

compressors, accumulators, coolers, pumps,

connecting pipes, and wiring for the mechanical

equipment for climate contr

olled rooms, walk-in

freezers, and coolers. See also Clean Room /

Climate Controlled Areas.

Allocation of HVAC is

not appropriate.

Personal

Property -

Note 1

HVAC - Hot or

Chilled Water

Systems

1250

All components of a building's or other inherently

permanent structure's hot or chilled water system(s)

used in the operation or maintenance of the building

or necessary to provide general building services

associated with the heating, ventilating, and air

conditioning system(s). Includes boilers, chillers and

cooling towers, pumps, valves, heat exchangers, air

handling units, piping (both source and return), etc.

See also Heating, Ventilating, Air Conditioning

(HVAC).

Building or

Building

Component –

39 Years

Industrial Steam

& Electric

1250 / 1245

Depreciable assets, whether such assets are

section 1245 property or 1250 property, used in the

00.4 in Rev.

Proc. 87-

183 | Page

ASSET

PROPERTY

TYPE

DESCRIPTION

RECOVERY

PERIOD

Generating

Systems

production and/or distribution of electricity with rated

total capacity in excess of 500

Kilowatts and/or

assets used in the production and/or distribution of

steam with rated total capacity in excess of 12,500

pounds per hour for use by the taxpayer in its

industrial manufacturing process or plant activity

and not ordinarily available for sal

e to others. Does

not include buildings and structural components as

defined in section 1.48

-1(e) of the regulations. See

Asset Class

56. 00.4

Industrial

Steam and

Electric

Generation

and/or

Distribution

Systems - 15

Years

Interstitial

Areas, Catwalks

and Mezzanines

1250

Interstitial areas created by fully enclosed decks and

walls between functional floors of a building,

catwalks and mezzanines that provide access to

various sections or levels of the building, or provide

more tha

n incidental working space. Designed to

remain in place indefinitely, require substantial time

and effort to construct or remove and integrated into

building design.

Building or

Building

Component –

39 Years

Interstitial

Areas, Catwalks

and Mezzanines

1245

Interstitial areas created by fully enclosed decks and

walls between functional floors of a building,

catwalks and mezzanines designed and constructed

only to provide access to inspect, repair, or operate

specific items of machinery or equipment.

Personal

Property -

Note 1

Landscaping &

Shrubbery

1250 / 1245

Depreciable improvements directly to or added to

land, whether such improvements are section 1245

or 1250 property. Examples include landscaping,

shrubbery, trees, and sod.

00.3 - Land

Improvements

but see Note 2

for exceptions

Loading Docks

1250

Bumpers, permanently installed dock levelers,

plates, seals, lights, canopies, docks, and overhead

doors used in the receiving and shipping of supplies

and raw materials, work in process, and finished

products inventories.

Building or

Building

Component –

39 Years

Machinery &

Equipment

1245

Tangible personal property, not covered elsewhere,

which is in the nature of machinery or equipment.

Includes a structure which is essentially an item of

machinery or equipment if the use of the structure is

so close

ly related to the use of such property that

the structure clearly can be expected to be replaced

when the property it initially houses is replaced.

Factors which indicate that a structure is closely

related to the use of the property it houses include

the

fact that the structure is specifically designed to

provide for the stress and other demands of such

property and the fact that the structure could not be

economically used for other purposes. Includes

such structures as oil and gas storage tanks, grain

Personal

Property -

Note 1

184 | Page

ASSET

PROPERTY

TYPE

DESCRIPTION

RECOVERY

PERIOD

storage bins, silos, fractionating towers, blast

furnaces, basic oxygen furnaces, coke ovens, brick

kilns, and coal tipples. Does not include structural

components of a building or other inherently

permanent structure. See also Plumbing; Electrical;

Heating,

Ventilating, Air Conditioning (HVAC); and

Elevators & Escalators.

Millwork

1250

General millwork is all building materials made of

finished wood (e.g., doors and frames, window

frames, sashes, porch work, mantels,

panel work,

stairways, and special woodwork). Includes pre

built

wooden items brought to the site for installation and

items constructed on site (such as restroom

cabinets, door jambs, moldings, trim, etc.).

Building or

Building

Component –

39 Years

Millwork

1245

Decorative millwork is the decorative finish

carpentry in a building. Examples include detailed

crown moldings, and lattice work placed over

finished walls or ceilings. The decorative millwork

serves to enhance the overall décor of the

building

and is not related to the operation of the building.

Excludes cabinets and counters in a restroom. See

also Restroom Accessories.

Personal

Property with

No Class Life -

7 Years

Office

Furnishings

1245

Desks, chairs, credenzas, file cabinets, tables,

bookcases, coat racks, projection screens, and

other office furniture such as workstations. Also

includes telephone equipment, fax machines, and

other communications equipment. Does not include

communications equipment included in other asset

classes in Rev. Proc. 87-56.

00.11 Office

Furniture,

Fixtures, and

Equipment – 7

Years

Parking Lots

1250 / 1245

Depreciable improvements directly to or added to

land, whether such improvements are section 1245

or 1250. Grade level surface parking and

base area

usually constructed of asphalt, brick, concrete,

stone or similar material. Also includes bumper

blocks, curb cuts, curb work, striping, concrete

landscape islands, truck parking ramps and staging

areas, and traffic control systems (such as traff

lights and detectors, card readers, parking

equipment, etc.). See also Roadways.

00.3 - Land

Improvements

but see Note 2

for exceptions

Parking

Structures

1250

Any structure or edifice the purpose of which is to

provide parking space. Includes gara

ges, parking

ramps, or other parking structures.

Building or

Building

Component –

39 Years

Plumbing

1250

All components of a building's or other inherently

permanent structure's plumbing distribution

system(s) used in the operation or

maintenance of

the building or necessary to provide general building

services such as drains, valves, water flow

Building or

Building

Component –

39 Years

185 | Page

ASSET

PROPERTY

TYPE

DESCRIPTION

RECOVERY

PERIOD

switches, restroom plumbing fixtures (e.g., toilets)

and piping, electric water coolers, and sprinkler

mains and heads. See also Gas & Sewer.

Plumbing

1245

Special plumbing connections which are necessary

to and used directly with a specific item of

machinery or equipment or connections between

specific items of individual machinery or

equipment.

Includes dedicated piping, valves, and hook

-ups by

which machinery and equipment is connected to the

building's or other inherently permanent structure's

plumbing distribution system(s). Does not include

plumbing hook

-ups of general applicability and

accessibility.

Personal

Property -

Note 1

Plumbing –

Special Water

Systems

1245

Special water systems separate from the building's

or other inherently permanent structure's plumbing

systems which are used to produce specialty water

such as dei

onized water (DI) or water for injection

(WFI) which is required in a manufacturing process

or research and experimentation activity. Includes

filters, tanks, pumps, specialized piping, valves, and

end use connections.

Personal

Property -

Note 1

Poles & Pylons

1250 / 1245

Poles made of metal or similar material usually set

in concrete footings or bolt

-mounted to concrete

piers. Their use is for supporting parking area lights,

signage, flags, etc. Pylons made of concrete, brick,

wood frame and

stucco, or similar materials usually

set in the ground or on a concrete foundation, and

usually used for signage. Note* asset class 00.3

Land improvements includes both section 1245 and

1250 property per Rev. Proc. 87

-56. See also Signs

and Electrical – Light Fixtures – Exterior.

00.3 - Land

Improvements

but see Note 2

for exceptions

Restaurant /

Cafeteria - In

Facility

Facilities that include a restaurant, cafeteria or other

commercial food preparation property such as a deli

or snack bar.

See Restaurant

Industry

Directive

Restroom

Accessories

1250

Paper towel dispensers, electric hand dryers, towel

racks or holders, cup dispensers, purse shelves,

toilet paper holders, soap dispensers or holders,

lotion dispensers, sanitary napkin dispensers and

waste receptacles, coat hooks, handrails, grab bars,

rrors, shelves, vanity cabinets, counters,

ashtrays, and other items that are built into or

mounted on walls or partitions.

Building or

Building

Component –

39 Years

Restroom

Partitions

1250

Shop made and standard manufacture toilet

partitions.

Building or

Building

Component –

39 Years

186 | Page

ASSET

PROPERTY

TYPE

DESCRIPTION

RECOVERY

PERIOD

Retail Store –

In Facility

A retail store or employee outlet, used to sell

merchandise (such as company products,

newspapers, magazines, film and digital images,

etc.).

See Retail

Industry

Directive

Roadways

1250 / 1245

Depreciable improvements directly to or added to

land, whether such improvements are section 1245

or 1250. Grade level driveways, roads, and base

areas usually constructed of asphalt, brick,

concrete, stone or similar material. Also includes

guard rails, curb cuts, and curb work.

00.3 - Land

Improvements

but see Note 2

for exceptions

Roof

1250

All elements of the roof including but not limited to

joists, rafters, deck, shingles, vapor barrier,

skylights, trusses, girders, and gutters.

Determinatio

n of whether decorative elements of a

roof (e.g., false dormers, mansard) constitute

structural building components depends on their

integration with the overall roof, not their load

bearing capacity. If removal of the decorative

element results in the dir

ect exposure of building

components to water, snow, wind, or moisture

damage, or if the decorative element houses lighting

fixtures, wiring, or other structural components, then

the decorative elements are part of the overall roof

system and are structural

components of the

building.

Building or

Building

Component –

39 Years

Security

Systems

1250

Security equipment for the protection of the building

(and its contents) from burglary or vandalism and

protection of employees from assault. Examples

include window and door locks; card key access

systems; keyless entry systems; security cameras,

recorders, monitors and related equipment;

perimeter and interior building motion detectors;

security lighting; alarm systems; and security

system wiring and conduit.

Building or

Building

Component –

39 Years

Security

Systems

1245

Electronic surveillance systems used to track and

monitor tangible items, e.g., raw materials, work in

process, and finished products inventories. Includes

scanners,

electronic gates, surveillance cameras,

recorders, monitors and related equipment.

Personal

Property -

Note 1

Sidewalks &

Curbs

1250 / 1245

Depreciable improvements directly to or added to

land, whether such improvements are section 1245

or 1250. S

idewalks and curbs are usually

constructed of concrete, asphalt, stone or similar

material.

00.3 - Land

Improvements

but see Note 2

for exceptions

Signs

1250

Exit signs, restroom identifiers, room numbers, fire

lanes, building identification, and other signs relating

to the operation or maintenance of a building.

Building or

Building

Component –

39 Years

187 | Page

ASSET

PROPERTY

TYPE

DESCRIPTION

RECOVERY

PERIOD

Signs

1245

Interior signs used to display directories of names,

departments, etc. Not related to the operation or

maintena

nce of a building. Exterior signs used to

display names, symbols, directions, etc. For pylon

signs, includes only the sign face and related

dedicated wiring. See also Poles & Pylons.

Personal

Property with

No Class Life -

7 Years

Site

Preparation,

Grading &

Excavation

N/A

Non-depreciable land preparation costs, in general,

include the one

time cost of demolition, clearing and

grubbing, blasting, site stripping, fill or excavation,

dewatering, and grading to allow

development of

land. Clearing and grubbing is the removal of debris,

brush, trees, etc. from the site. Stripping is the

removal of the topsoil to provide a stable surface for

site and building improvements. The grading of land

involves moving soil for the

purpose of producing a

more level surface to allow development of the land.

These costs would not have to be reincurred if the

building was repaired, rebuilt, or even torn down

and replaced with some other type of building.

Land - Not

Depreciable

Site

Preparation,

Grading &

Excavation

1250

Depreciable clearing, grading, excavating and

removal costs directly associated with and

necessary for the proper setting of the building and

building components are part of the cost of

construction of the building. Se

e also Concrete

Foundations & Footings.

Building or

Building

Component –

39 Years

Site

Preparation,

Grading &

Excavation

1250

Depreciable clearing, grading, excavating and

removal costs directly associated with the

construction of sidewalks,

parking areas, roadways

and other depreciable land improvements are part

of the cost of construction of the improvements.

00.3 - Land

Improvements

but see Note 2

for exceptions

Site Utilities

1250

Site utilities begin where the responsibility rests with

he taxpayer and not the utility company which is

providing the service. Site utilities end at either a

building or other permanent structure. Site utilities

also include any distribution systems between

buildings or other permanent structures. The cost of

the site utilities would not have to be reincurred if

the building or other permanent structure was

repaired, rebuilt, or even torn down and replaced

with some other type of building. Typically the

utilities provided would be electricity, natural gas,

wate

r, sewer, and steam. See also Electrical,

Plumbing, and Gas & Sewer.

Building or

Building

Component –

39 Years

Site Utilities

1250

Drainage facilities and sewers that are not municipal

sewers.

00.3 - Land

Improvements

but see Note 2

for exceptions

188 | Page

ASSET

PROPERTY

TYPE

DESCRIPTION

RECOVERY

PERIOD

Sound Systems

1245

Equipment and apparatus, including wiring, used to

provide amplified sound or music (e.g., public

address by way of a paging system or background

music). Excludes applications linked to fire

protection and alarm systems.

Personal

Property With

No Class Life -

7 Years

Trash

Enclosures

1250

Enclosures attached to the building for waste

receptacles. Typically constructed of the same

materials as the building shell with either interior or

exterior access. These trash

enclosures are an

integral part of the building shell and cannot be

moved without damage to the underlying building.

Building or

Building

Component –

39 Years

Trash

Enclosures

1250

Freestanding enclosures, typically constructed on a

concrete pad

with its posts set in the concrete, for

waste receptacles. Serves both safety and

decorative functions.

00.3 - Land

Improvements

but see Note 2

for exceptions

Wall Coverings

1250

Includes interior and exterior paint; ceramic or

quarry tile,

marble, stone, brick, and other finishes

affixed with mortar, cement, or grout; paneling,

wainscoting, and other wood finishes affixed with

nails, screws, or permanent adhesives; sanitary

finishes such as Fiberglass Reinforced Plastic

(FRP), stainless steel, or plastic; sound absorbing or

fabric wall panels; and wall protection (such as

bumpers, corner guards, etc.).

Building or

Building

Component –

39 Years

Wall Coverings

1245

Strippable wallpaper that causes no damage to the

underlying wall or wall su

rface.

Personal

Property with

No Class Life -

7 Years

Walls - Exterior

1250

All exterior walls and building support regardless of

construction materials. Exterior walls may include

columns, posts, beams, girders, curtain walls, tilt up

panels, studs, framing, sheetrock, insulation,

windows, doors, exterior façade, brick, masonry,

etc.

Building or

Building

Component –

39 Years

Walls - Interior

1250

All load bearing interior partitions regardless of

construction. Also includes non

-load bearing

partitions regardless of height (typically constructed

of studs and sheetrock or other

materials) that

divide or create rooms or provide traffic control.

Includes rough carpentry and finishes such as

plaster, dry wall, gypsum board, concrete block,

glass, or metal.

Building or

Building

Component –

39 Years

Walls - Interior

1245

Interior walls where the partition can be 1) readily

removed and remain in substantially the same

condition after removal as before, or 2) moved and

reused, stored, or sold in their entirety.

Personal

Property with

No Class Life -

7 Years

189 | Page

ASSET

PROPERTY

TYPE

DESCRIPTION

RECOVERY

PERIOD

Window

Treatments

1245

Window treatments which are readily removable

such as drapes, curtains, louvers, blinds, post

construction tinting, etc.

Personal

Property with

No Class Life -

7 Years

Windows

1250

Exterior and interior windows.

Building or

Building

Component –

39 Years

NOTES

Note 1: The recovery period depends on the use of the property. See the Cost Segregation Audit Techniques

Guide Appendix Chapter 6.3 for examples and application of the asset classification rules of Revenue

Procedure 87-56 activity classes 01.1 to 80.0 or "Certain Property for Which Recovery Periods Assigned"

letters A through E at the end of Revenue Procedure 87-56.

Note 2: Land improvements are included in some activity classes in Revenue Procedure 87-56. See the Cost

Segregation Audit Techniques Guide Appendix Chapter 6.3 for examples and application of the asset

classification rules of Revenue Procedure 87-56.

CAUTION: In the case of certain leasehold improvement property, the classifications in this directive are

superseded to the extent that the American Jobs Creation Act of 2004 modifies IRC Section 168. Thus, a 15-

year straight line recovery period should replace the recovery period shown in the above matrix if the asset is

“qualified leasehold improvement property" (as defined in IRC Section 168(e)(6)) placed in service by the

taxpayer after 10/22/04 and before 1/1/08.

190 | Page

E. Auto Dealership Industry

Field Directive on the Planning and Examination of Cost Segregation Issues in the

Auto Dealership Industry

LMSB Control No. 4-0208-006

Impacted IRM 4.51.5

February 25, 2008

MEMORANDUM FOR INDUSTRY DIRECTORS, LMSB

DIRECTOR, PREFILING AND TECHNICAL GUIDANCE, LMSB

DIRECTOR, FIELD SPECIALISTS, LMSB

DIRECTOR, INTERNATIONAL COMPLIANCE, LMSB

LMSB AREA COUNSEL

FROM: /s/ Charlie Brantley

Industry Director, Heavy Manufacturing and Transportation

SUBJECT: Field Directive on the Planning and Examination of Cost Segregation Issues in the Auto

Dealership Industry

INTRODUCTION

This Directive is intended to provide technical guidance to effectively reduce exam time and taxpayer burden.

The matrix contained in attachment A is a new chapter in the Cost Segregation Audit Technique Guide. This

matrix will provide assistance to agents in the classification and examination of a taxpayer who is recovering

costs through depreciation of tangible property used in the Auto Dealership Industry.

BACKGROUND

The crux of cost segregation is determining whether an asset is I.R.C. §1245 property (shorter cost recovery

period property) or §1250 property (longer cost recovery period property). The most common example of

§1245 property is depreciable personal property, such as equipment. The most common examples of §1250

property are buildings and building components, which generally are not §1245 property.

The difference in recovery periods has placed the Internal Revenue Service and taxpayers in adversarial

positions in determining whether an asset is §1245 or §1250 property. Frequently, this causes the excessive

expenditure of examination resources. The Director for the Heavy Manufacturing and Transportation Industry

chartered a working group to address the most efficient way to approach cost segregation issues specific to

the Auto Dealership Industry. The group produced the attached matrix and related definitions as a tool to

reduce unnecessary disputes and foster consistent audit treatment.

ISSUE TRACKING

I.R.C. §1245 can apply to certain qualified recovery nonresidential real estate placed in service after 1980

and before 1987. See I.R.C. §1245(a)(5).

191 | Page

UIL Code 168-20-00 Classification of Property.

PLANNING AND EXAMINATION RISK ANALYSIS

The Auto Dealership Industry Matrix recommending the categorization and general depreciation system

recovery period of various assets is attached as Exhibit A. (for recovery periods under IRC §168(g) alternative

depreciation system, see Revenue Procedure 87-56, 1987-2 CB 674). If the taxpayer’s tax return position for

these assets is consistent with the recommendations in Auto Dealership Matrix (Exhibit A), examiners should

not make adjustments to categorization and recovery periods. If the taxpayer reports assets differently, then

adjustments should be considered.

Please consider the Cost Segregation Audit Techniques Guide in its entirety. Refer especially to Appendix

Chapter 6.3, which provides examples and general rules for asset classification.

INTERNAL COMMUNICATIONS

Questions regarding the development of the Cost Segregation issue for Auto Dealerships should be

addressed to the Deductible and Capital Expenditures (DCE) Practice Network. his LMSB Directive is not

an official pronouncement of the law or the position of the Service and cannot be used, cited or relied

upon as such.

Attachment: Exhibit A

Attachment

LMSB DIRECTIVE ON COST SEGREGATION IN THE AUTO DEALERSHIP INDUSTRY

EXHIBIT A

This matrix, which is part of the Cost Segregation Audit Techniques Guide, is intended to provide direction to

effectively utilize resources in the classification and examination of property used in the operation of an Auto

Dealership. General fact patterns specific to this industry have been considered in the classification of these

assets and may not be applicable to other industries. Similarly, asset classification guidance issued for other

industries is based on the general fact pattern for that industry and may not be applicable to an Auto

Dealership situation. For examination techniques and historical background related to this issue, refer to the

Cost Segregation Audit Techniques Guide.

NOTE: In the case of certain leasehold improvement property, the classifications in this directive are

superseded to the extent that the American Jobs Creation Act of 2004 modifies IRC Section 168. Thus, a 15-

year straight line recovery period should replace the recovery period shown in the following matrix if the asset

is “qualified leasehold improvement property" (as defined in IRC Section 168(e)(6)) placed in service by the

taxpayer after 10/22/04 and before 1/1/08.

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

Awnings &

Canopies

Readily removable overhang or covering, often of

canvas or plastic, used to provide shade or cover

over a storefront, a window, or a door; or used inside

a structure to identify a particular department or

selling area. Also includes canopies designed to

§ 1245

57.0

Distributive

Trades and

Services

5 Years

192 | Page

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

protect employees and gasoline fueling equipment

from weather conditions and to act as advertising

displays that are anchored with bolts and are not

attached to buildings or other structures. Does not

include permanent canopies that are an integral part

of a

building’s structural shell, such as porte-cochere

(covered entrances for vehicle drive

-up) and porticos

(covered porches), or over docks. See also Concrete

Foundations & Footings,

Loading Docks, and

Signs.

Bollards &

Guardrails

Bollards (heavy steel posts generally filled with

concrete) and Guardrails mounted in a concrete

foundation or sturdily affixed to the ground so as to

create a protective barrier around areas of the

building vulnerable to ve

hicle traffic such as Service

Bay doors, glass storefront partitions, doors, door

frames, HVAC components, building corners, etc.

Bollards and Guardrails can be located inside or

outside the building are permanently attached and are

intended to be permanen

t. (Placement to protect the

building).

§ 1250

Building or

Building

Component

–

39 Years

Bollards &

Guardrails

Bollards (heavy steel posts generally filled with

concrete) and Guardrails mounted in the ground or

concrete to protect machinery and

equipment from

vehicular damage, or to prevent vehicles from

trespassing onto specific areas. Placement to protect

land improvements and non

-building items such as

signs, sign poles, flagpoles, trees, as well as

inventories of autos and trucks. Bollard and

Guardrails are permanently attached and intended to

be permanent.

Note* asset class 00.3 Land improvements

includes both section 1245 and 1250 property per

Rev. Proc. 87-56.

See Note*

00.3 Land

Improvements

–

15 Years

Bollards &

Guardrails

Bollards (heavy steel posts) and Guardrails, not

permanently attached and not intended to be

permanent, placed near machinery and equipment

inside buildings that can be damaged by vehicular

traffic. Bollards and Guardrails withstand vehicular

impact and pr

otect personal property items such as:

forklift recharging stations, service write

-up station,

hazardous material storage racks, service department

air compressors, etc.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Cabinetry

Includes cabinets and counters constructed or

installed within buildings that relate to the general

operation and maintenance of the building. For

example, cabinets and counters used to house or

enclose electrical equipment, plumbing components,

sinks, fire protection systems, and other structural

§ 1250

Building or

Building

Component

–

39 Years

193 | Page

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

elements of a building which are designed to remain

in place. Includes counters and cabinets in restrooms,

Employee Break Areas, Employee Coffee Bars,

and Office Areas. See also Restroom Accessories.

Cabinetry

Includes cabinets and counters related to the retail

activity and not related to the operation and

maintenance of the building. For example: retail

counters and cabinets, display shelving and cabinets,

custome

r reception counter, Customer Lounge Area

cabinets and counters,

Sales Area cabinets and

counters, parts counters, etc. See also

Retail

Fixtures and Office Furniture.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Computers

Processors (CPU), direct access storage device

(DASD), tape drives, desktop and laptop computers,

CRT, terminals, monitors, printers, and other

peripheral equipment. Excludes Point of Sale (POS)

systems and computers that are an integral part of

other equi

pment (e.g. fire detection, heating, cooling,

or energy management systems, etc.). See also

Point of Sale (POS) Systems.

§ 1245

00.12

Information

Systems

–

5 Years

Concrete

Foundations &

Footings

Foundations and footings necessary for the proper

setting of the building. Excavation and backfill for

building foundations. Excavation and backfill for

special equipment foundations where contained

within the footprint of the building. Includes formwork,

reinforcement, concrete block, and pre

-cast or cast-

in-place work.

§ 1250

Building or

Building

Component

–

39 Years

Concrete

Foundations &

Footings

Foundations or footings for signs, light poles, and

other land improvements (except buildings). Includes

excavation, backfill, formwork, reinforcement,

concrete block, and pre

-cast or cast-in-place work.

Note* asset class 00.3 Land improvements

includes b

oth section 1245 and 1250 property per

Rev. Proc. 87-56.

See Note*

00.3 Land

Improvements

–

15 Years

Concrete

Foundations &

Footings

A foundation, pad, or footing for machinery or

equipment that is so specially designed that it is in

essence a part of the machinery or equipment. Any

function as a building component must be strictly

incidental to the function as an essential part of the

item of machinery or equipment that necessitated the

special design of the foundation. Increased thickness

of the building’s slab alone is not sufficient to show

that the foundation, pad, or footing is so specially

designed that it is in essence a part of

the machinery

or equipment it supports. Excavation and backfill are

not included where the foundation, pad, or footing is

contained within the footprint of the building. Includes

formwork, reinforcement, concrete block, and pre

cast

or cast-in-place work.

§ 1245

57.0

Distributive

Trades and

Services

–

5 Years

194 | Page

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

Data Handling

Equipment

Includes adding and accounting machines,

calculators, copiers, and duplicating machines.

Excludes computers and computer peripheral

equipment.

§ 1245

00.13 Data

Handling

Equipment,

except

Computers

–

5 Years

Doors

Interior and exterior doors, regardless of decoration,

including but not limited to, double opening doors, fire

doors and fire containment safety doors, overhead

and roll

-up doors, revolving doors, roll-up or sliding

wire mesh or steel grills,

Service Bay doors, and

related door hardware (such as doorknobs, closers,

kick plates, hinges, locks, automatic openers,

computerized door locks, etc.). See also Millwork.

§ 1250

Building or

Building

Component

–

39 Years

Doors

Special lightweight, double action doors installed to

prevent accidents in a heavily trafficked area. For

example, flexible doors, or clear or strip curtains used

between stock and selling areas.

§ 1245

57.0

Distributive

Trades and

Services

–

5 Years

Electrical

Includes all components of the building electrical

system used in the operation or maintenance of the

building or necessary to provide general building

services such as electrical outlets of general

applicability and accessibility, lighting, heating,

venti

lation, air conditioning, and electrical wiring.

Includes but is not limited to general purpose outlets

connected to copy machines, fax machines, personal

computers, and general purpose outlets in the

Break

Rooms, Coffee Rooms, Lounges, etc.

§ 1250

Building or

Building

Component

–

39 Years

Electrical

Includes electrical outlets specifically associated to a

particular item of machinery or equipment located in

the

Service Department, Body Shop, and

Showroom

. Special electrical connections which are

necessary to and used directly with a specific item of

achinery or equipment or connections between

specific items of individual machinery or equipment;

such as dedicated electrical outlets, wiring, conduit,

and circuit breakers by which machinery and

equipment is connected to the electrical distribution

syste

m. Does not include electrical outlets of general

applicability and accessibility. See Chapter 5 of the

Cost Segregation Audit Techniques Guide for

allocation examples.

Examples include: Dedicated electrical service to lifts,

jacks and

Service Bay equipment; paint booths; car

washes; oil change stations; frame straightening

equipment and

Body Shop

equipment. Also includes

dedicated electrical to

Customer Areas, such as

suspended television monitors.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

195 | Page

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

Elevators and

Escalators

Elevators and escalators, which include handrails and

smoke baffles, are permanently affixed to the building

and intended to remain in place. They relate to the

operation or maintenance of the building and are

structural componen

ts.

Includes elevators to move autos in multi

-story

dealerships.

§ 1250

Building or

Building

Component

–

39 Years

Energy

Management

Systems

Energy management systems control all energy-using

systems in a building, automatically checking

occupancy

schedules, reading temperatures, and re-

circuiting light levels, causing all heating, cooling and

lighting equipment to operate so as to minimize

energy costs. Includes, for example, detection

devices such as smoke, motion and infrared devices,

photocells,

foil and contact switches, pressure

switches, proximity alarms, sensors, alarm

transmitting controls, data gathering panels, demand

controllers, thermostats, computer controls, outside

air economizers, occupancy sensors, electronic

ballasts, and all relat

ed wiring and conduit. May also

provide for fire and burglary protection.

§ 1250

Building or

Building

Component

–

39 Years

Exit Signs

Signs posted along exit routes within buildings that

indicate the direction of travel to the nearest exit.

These

signs typically read "EXIT" and may have

distinctive colors, illumination, or arrows indicating the

direction to the exit.

§ 1250

Building or

Building

Component

–

39 Years

Fire Protection

& Alarm

Systems

Includes sensing devices, computer controls,

sprink

ler heads, piping or plumbing, pumps, visual

and audible alarms, alarm control panels, heat and

smoke detection devices, fire escapes, fire doors,

emergency lighting and signage, and wall mounted

fire extinguishers necessary for the protection of the

building.

§ 1250

Building or

Building

Component

–

39 Years

Fire Protection

Equipment

Includes special fire detection or suppression systems

directly associated with a piece of equipment and

designed and used for protection against a particular

hazard created b

y the business activity (such as in

the Body Shop).

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Floor Coverings

Floor covering affixed with permanent adhesive,

nailed, or screwed in place. Examples include

ceramic or quarry tile, marble, paving brick, and other

coverings cemented, mudded, or grouted to the floor;

epoxy or sealers; and wood flooring.

§ 1250

Building or

Building

Component

–

39 Years

Floor Coverings

Floor covering that is installed by means of strippable

adhesives. For the auto dealership industry, all vinyl

composition tile (VCT), sheet vinyl, and carpeting will

be treated as not permanently attached and not

intended to be permanent.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

196 | Page

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

Floors

Includes concrete slabs and other floor systems.

Floors include special treatments applied to or

otherwise a permanent part of the floor. For example,

reflective flooring, express lube and reconditioning

area floors, and epoxy floor paint or sealant applie

directly to the concrete slab to keep a sealed, water

and oil resistant, easy

-to-clean surface. See also

Floor Coverings.

§ 1250

Building or

Building

Component

–

39 Years

Floor Pits &

Trenches

Work areas built at a lower level than the garage floor

to allow technicians to stand beneath the vehicles

while working. These floor pits allow the technician to

service a vehicle from below (for example, to change

automotive oil, radiator and transmission fluids). Work

areas include pits and trenches wi

th concrete floors

and walls with overhead access to vehicles. Some of

these floor pits resemble full basements allowing

multiple technicians access to vehicles above.

§ 1250

Building or

Building

Component

–

39 Years

Floor Pits &

Trenches

Equipment included in the floor pits & trenches such

as lifts, trays, and piping for supply fluid systems;

waste fluid recovery and containment systems; and

automotive fluid waste tanks.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Heating,

Ventilating &

Air

Conditioning

(HVAC)

Includes all components of a central heating,

ventilating and air conditioning system not specifically

identified elsewhere. HVAC systems that are installed

not only to meet the temperature and humidity

requir

ements of machinery, but are also installed for

additional significant purposes, such as customer

comfort and ventilation, are building components.

§ 1250

Building or

Building

Component

–

39 Years

Heating,

Ventilating &

Air

Conditioning

(HVAC)

Only separate HVAC units that meet the sole

justification test are included (i.e., machinery the sole

justification for the installation of which is the fact that

such machinery is required to meet temperature or

humidity requirements which are essential f

or the

operation of other machinery or the processing of

materials or paint). For example, special ventilation

for paint booths;

Body Shop and Service Area

exhaust removal systems. Allocation of HVAC is not

appropriate.

§ 1245

57.0

Distributive

Trades a

Services

5 Years

Inventory

Display

Equipment

Includes inventory displays that are permanently

added to the land. Examples include concrete ramps

and pedestals, and exterior “turntable” displays that

are permanently affixed, etc.

Note* asset

class 00.3 Land improvements

includes both section 1245 and 1250 property per

Rev. Proc. 87-56.

See Note*

00.3 Land

Improvements

–

15 Years

Inventory

Display

Equipment

Includes inventory displays that are not permanently

added to the land and

intended to be moved.

§ 1245

57.0

Distributive

197 | Page

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

Examples include metal ramps, portable “turntable”

displays, etc.

Trades and

Services

5 Years

Landscaping &

Shrubbery

Landscaping that will not be replaced

contemporaneously with a related

depreciable asset

or that will not be destroyed when the related

depreciable asset is replaced. Examples include

landscaping, shrubbery, trees, plant foliage, or sod

placed around the perimeter of the tract of land.

Land

Landscaping &

Shrubbery

Landscaping that will be replaced contemporaneously

with a related depreciable asset or that will be

destroyed when the related depreciable asset is

replaced. Examples include depreciable landscaping,

shrubbery, trees, plant foliage, or sod placed around

he parking lot in outdoor Sales Area. Includes

associated irrigation systems (sprinkler systems).

Note* asset class 00.3 Land improvements

includes both section 1245 and 1250 property per

Rev. Proc. 87-56.

See Note*

00.3 Land

Improvements

–

15 Years

Light Fixtures -

Interior

Includes lighting such as recessed and lay-in lighting,

night lighting, and exit lighting, as well as decorative

lighting fixtures that provide substantially all the

artificial illumination in the building or along building

walkw

ays. For emergency and exit lighting, see Fire

Protection & Alarm Systems.

§ 1250

Building or

Building

Component

–

39 Years

Light Fixtures -

Interior

Special display lighting specifically for highlighting

automobiles in the

Showroom, or highlighting

displays of merchandise, decorative lighting, and

specific task lighting in the service area. Decorative

light fixtures are light fixtures, such as neon lig

hts or

track lighting, which are decorative in nature and not

necessary for the operation of the building. If the

decorative or task lighting were turned off, the other

sources of lighting would provide sufficient light for

operation of the building. If th

e decorative or task

lighting is the

primary source of lighting, then it is

section 1250 property.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Light Fixtures -

Exterior

Exterior lighting is considered section 1250 property

to the extent

that the lighting relates to the

maintenance or operation of the building. This

category includes building mounted lighting to

illuminate walkways, entrances, parking, etc

(whether

decorative or not).

§ 1250

Building or

Building

Component

–

39 Years

Light Fixtures -

Exterior

Pole mounted or freestanding outdoor lighting system

to illuminate sidewalks,

Employee Parking Area,

Customer Parking Area, and Product Display

Parking Areas. See also Poles.

See Note*

00.3 Land

Improvements

–

15 Years

198 | Page

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

Note* asset class 00.3 Land improvements

includes bot

h section 1245 and 1250 property per

Rev. Proc. 87

-56.

The Revenue Procedure establishes two broad

categories of depreciable assets: (1) asset classes

00.11 through 00.4 that consist of specific assets

used in all business activities; and (2) asset classes

01.1 through 80.0 that consist of assets used in

specific business activities. An asset described in

both an asset and an activity category is classified in

the asset category.

Light Fixtures –

Exterior

Exterior lighting that highlights the merchandise and

building exterior, for example a floodlight, spotlight,

and uplighting which do not illuminate parking areas

or walkways. Does not include the pole mounted

lighting systems used to illuminate

Employee

Parking Area, Customer Parking Area, and

Product Display Parking Areas. See also Poles.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Loading Docks

Includes bumpers, permanently installed dock

levelers, plates, seals, lights, canopies, and overhead

doors used in the receiving and shipping of

merchandise. See also Awnings & Canopies.

§ 1250

Building or

Building

Component

–

39 Years

Loading Docks

Includes equipment such as compactors, conveyors,

hoists and balers.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Machinery &

Equipment

Tangible personal property not covered elsewhere,

which is in the nature of machinery or equipment.

Includes, for example, machinery and equipment

located in the

Body Shop, Parts Department and

Service Departments

such as paint booths; exhaust

systems; air

compressors; pneumatic tools systems

(including support equipment such as piping and

related pumps); tanks and related pumps; automotive

fluid and waste fluid recovery systems; above

-ground

lifts; car wash systems, etc. Does not include

structural components of a building or other inherently

permanent structure. See also Concrete Foundation

& Footings; Electrical; and Plumbing.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Millwork

General millwork is all building materials made of

finished wood (e.g., doors and frames, window

frames, sashes, porch work, mantels, panel work,

stairways, and special woodwork). Includes pre

-built

wooden items brought to the site for installation and

ite

ms constructed on site such as restroom cabinets,

door jambs, moldings, trim, etc.

§ 1250

Building or

Building

Component

–

39 Years

Millwork

Decorative millwork is the decorative finish carpentry

in the building. Examples include detailed crown

§ 1245

57.0

Distributive

199 | Page

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

moldings, lattice work placed over finished walls or

ceilings, and merchandise display cabinets. The

decorative millwork serves to enhance the overall

décor of the dealership and is not related to the

operation of the building. Cabinets and counters in

the restroom are excluded from this category. See

also Cabinetry and Restroom Accessories.

Trades and

Services

5 Years

Office –

Furniture

(includes

Communication

Equipment and

Hook-ups)

Includes desks, chairs, cashiers safes, credenzas, file

cabinets, tables (or other furniture such as

workstations and the

Sales Manager’s office tower)

and shelving, including cost of shel

ves in record

storage room. Also includes telephone equipment, fax

machines, and other communications equipment.

Does not include communications equipment included

in other asset classes in Rev. Proc. 87-56.

§ 1245

00.11 Office

Furniture,

Fixtures, and

Equ

ipment –

7 Years

Parking Lots

Depreciable improvements directly to or added to

land, whether such improvements are section 1245 or

1250. Grade level surface parking and base area

usually constructed of asphalt, brick, concrete, stone

or similar material. Also includes bumper blocks, cu

cuts, curb work, striping, concrete landscape islands,

gates, fences, truck parking ramps and staging areas,

and traffic control systems (such as traffic lights and

detectors, card readers, parking equipment, etc.).

Includes

Employee Parking, Customer P

arking, and

New and Used Vehicle Parking Areas.

Note* asset class 00.3 Land improvements

includes both section 1245 and 1250 property per

Rev. Proc. 87

-56.

The Revenue Procedure establishes two broad

categories of depreciable assets: (1) asset

classes

00.11 through 00.4 that consist of specific assets

used in all business activities; and (2) asset classes

01.1 through 80.0 that consist of assets used in

specific business activities. An asset described in

both an asset and an activity category is

classified in

the asset category.

See Note*

00.3 Land

Improvements

–

15 Years

Parking

Structures

Any structure or edifice the purpose of which is to

provide parking space. Includes, for example,

garages, parking ramps, or other parking

structures.

§ 1250

Building or

Building

Component

–

39 Years

Plumbing

All piping, drains, sprinkler mains, valves, sprinkler

heads, water flow switches, restroom plumbing

fixtures (e.g. toilets) and piping, sinks, electric water

coolers, and all other co

mponents of a building

plumbing system (water or gas) not specifically

identified elsewhere. Includes floor drains which

ultimately lead to the municipal sewer system or site

septic system.

§ 1250

Building or

Building

Component

–

39 Years

200 | Page

ASSET DESCRIPTION

PROPERTY

TYPE

RECOVERY

PERIOD

Plumbing

Special plumbing connections which are necessary to

and used directly with a specific item of machinery or

equipment or connections between specific items of

individual machinery or equipment. Includes

dedicated piping, valves, and hook

-ups by which

machinery and equipment is connected to the building

or other inherently permanent structure's plumbing

distribution system(s).

Example includes plumbing hook

ups to the car wash

system. Does not include plumbing hook

-ups of

general applicability and accessibil

ity. See also Floor

Pits & Trenches.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Point of Sale

(POS) Systems

A register or terminal based data collection system

used to control and record all sales (cash, charge,

COD, gift cards, layaway, etc.) at the point of sale.

Includes cash registers, computerized sales systems

and related peripheral equipment, satellite sy

stems,

scanners, and wands. See also

Electrical for hook-

ups.

§ 1245

57.0

Distributive

Trades and

Services

5 Years

Poles

Light poles for parking areas and other poles poured

in concrete footings or bolt

-mounted for signage,

flags, etc.

Note* asset class 00.3 Land

improvements includes both section 1245 and

1250 property per Rev. Proc. 87

-56.