How to Achieve the 45L Home Energy Efficient Tax Credit

We have outlined some very important items developers should take into consideration in order to achieve the energy efficient standards for the 45L tax credit. Of course, there are a lot of factors including climate zone that are measured but if a developer pays attention to these items, they will be in much better shape. Keep in mind that they are not required in order for a unit to pass, but they do help considerably if employed.

New Construction

  • Whole house fan for cooling strategy: This can also be a fan-only fresh air option on a wall unit air conditioner or PTAC
  • Mechanical ventilation for indoor air quality: This a great idea for homes, townhouses and apartments larger than 1500 square feet.
  • All ducts & HVAC equipment should be inside conditions space and not run in the attic, crawl space or garage.
  • Wall insulation of R-19 or better for dwellings outside the Deep South. Rigid foam board or insulated sheathing is also beneficial.
  • Foundation wall insulation: R-7 around the perimeter is preferred but under slab insulation works well also.
  • Quality Windows: Energy Star windows are a bare minimum. U-values are important in northern states and solar heat gain coefficients (SHGC) are better in the south.

Rehabs

  • Wall insulation of R-19 or better for dwellings outside of the Deep South. Rigid foam board or insulated sheathing is also beneficial.
  • HVAC Equipment. If constraints don’t allow exterior walls to be insulated to R-19, then the efficiency of the HVAC equipment is vital. At least SEER 14 for A/Cs and 95% AFUE for heating is recommended.
  • Ventilation. When replacing PTACs, VTACs, wall unit A/Cs and other similar equipment, choose those that have a fan-only fresh air option.
  • Quality Windows. Energy Star windows are a bare minimum. U-values are important in northern states and solar heat gain coefficients (SHGC) are better in the south.
  • Attic Insulation. Northern climates should have additional attic insulation installed to R-50 and southern states should have at least R-38.

Have a project you would like to have evaluated? Contact us here.

Back to the Future: What if Marty McFly Had Been a Property Investor

In order to keep moving forward and appreciate where we are, you must look back occasionally and evaluate where we have been in years past.


 

Back to the Future with Real Estate Investors

Investors who owned real estate in 1999, specifically those who owned commercial properties, had a great year. Had Marty McFly been a property investor he would have time traveled to 1999 allowing him to take advantage of the April 1999 IRS legal memorandum. Why was 1999 significant for real estate investors and how could taking a look back affect your future?

In a strange but true “Back to the Future” paradox, a 1985 film starring Michael J. Fox and Christopher Lloyd was released. It’s “Strange” because the movie had nothing to do with cost segregation and “True” because had the events of the movie been written by a CPA, they would have undoubtedly proven a more applicable and profitable future for Marty as a property investor – the type of investor who finds purchasing hotels to be more than exciting enough on a daily basis.

In a strange but true “Back to the Future” paradox, a 1985 film starring Michael J. Fox and Christopher Lloyd was released. It’s “Strange” because the movie had nothing to do with cost segregation and “True” because had the events of the movie been written by a CPA, they would have undoubtedly proven a more applicable and profitable future for Marty as a property investor – the type of investor who finds purchasing hotels to be more than exciting enough on a daily basis.

As a property investor, Marty would have time traveled to 1999 in order to take advantage of the April 1999 IRS legal memorandum. The memorandum stated that taxpayers could segregate various building costs into shorter depreciable lives for tax purposes. In other words, personal property within a building and land improvements previously considered 39 or 27.5-year assets could finally be captured as 5 and 1 property via a cost segregation study. This memorandum was significant to all real estate investors because items like carpet clearly will not last 39 years. The structure of a building does not only consist of the walls, roof, and some interior rooms, but includes other items like land improvements (storm sewers, curbs and sidewalks, parking lots, swimming pools, landscaping, etc.) and personal property (flooring, interior finishes, decorative lighting, kitchens, interior glass and electrical wiring for appliances, etc.). It’s easy to see how these strategies serve as a powerful tax tool for property investors. For example, imagine that Marty decided to buy an apartment complex for $1.2M. These memorandums would have allowed Marty to capture $420,000 as 5 and 15-year property via a cost segregation study. With the increased cash flow, he would have had enough money to invest in additional apartment complexes.With 2016 tax planning just around the corner, like Marty, real estate owners should consider the benefits of cost segregation to free up their cash flow. The following will explain how you can take advantage of it while offering a few insider tips to get the most benefit.

As noted, a property’s structure is generally subject to a 39-year recovery period while land improvements qualify for a 15-year recovery period and personal property qualifies for a 5-year recovery period. As a property investor, let’s say you installed new flooring throughout your building. Every year, you can write that flooring off on your taxes until the end of its useful life. That period of time that the asset depreciates is considered the recovery period and the shorter the recovery period, the greater the reduction in tax liablity. Typically, a building will yield 25%-35% of the total costs that can be segregated into land improvements and personal property. You can become a savvy real estate investor by simply understanding this concept and how it can be used for future investments or repairs and maintenance on current investments.

A cost segregation study applies the correct recovery period to the building from the date it was placed in service. If the property owner has already filed two or more federal income tax returns using an incorrect method of depreciation, an Accounting Method Change can be applied to capture the missed depreciation. This “catch-up” in depreciation is realized in the current year, by means of a 481(a) adjustment calculation and an Accounting Method Change is reported on Form 3115 without the need to amend prior year tax filings. Rev. Proc. 87-56 provides the taxpayer with general depreciation guidelines for use in both a cost segregation study and/or Change of Accounting Method.

Since depreciation is a non-cash flow item, application of cost segregation could provide a significant impact on this years tax return. For example, a substantial tax benefit may be achieved by applying a cost segregation study to a residential rental building which was placed-in-service on 6/15/2010. With a purchase price of $10M (20% land; 80% structure) and an average allocation of 15% to 5-year class property and 10% to 15-year class property, the “catch up” in depreciation, taken in the current year as an “other deduction,” would be in the amount of $1,122,962.00 (see example below).

I think it is safe to say that all current and future property investments should consider the benefits of cost segregation. The April 1999 IRS legal memorandum and associated provisions have made cost segregation one of the most powerful tax strategies for real estate today. Realistically, all properties can benefit from a cost segregation study as long as they are investment properties because they are the only properties subject to depreciation. If you own an investment property, an engineering-based cost segregation study analysis can determine what the benefit will look like in order to ensure a study makes financial sense. As noted herein, the impact of the reclassification is usually significant when pursued properly.

IRS Notice 2017-6 Creates Window of Opportunity to Unlock Tax Savings for Some Taxpayers

The IRS issued Notice 2017-6 to extend the time to make certain changes to comply with the tangible property regulations. This includes making accounting method changes for repair and maintenance expenses, depreciation, and certain property dispositions. This extension may present a significant opportunity to unlock tax savings for taxpayers who previously made accounting method changes to comply with the tangible property regulations. This will probably be the last opportunity these taxpayers have to realize these tax savings.

The Tangible Property Regulations

The tangible property regulations have been a work-in-process for more than a decade. The regulations were issued in 2011 in temporary form effective for tax years 2012 and in 2013 in final form, effective for 2014. There were significant differences between the temporary and final regulations.

Most of the rules found in the regulations are accounting method changes that require the consent of the IRS to change. The IRS issued a number of lengthy and nuanced revenue procedures and notices that explain how to obtain the IRS’s consent. This included guidance for automatic consent (via a Form 3115) and non-automatic consent (via a private letter ruling).

Tax advisors and their clients complained that the IRS’s guidance was not issued in time for them to fully analyze and comply with the complex rules. The IRS issuing this guidance as the regulations were changing also did not help. This resulted in the IRS taking steps to help taxpayers comply with the regulations and accounting method rules.

The Problem Notice 2017-6 Solves

One of the accounting method change rules prevents taxpayers from obtaining the IRS’s automatic consent if the taxpayer made a change for the issue in the prior five years. This means that taxpayers can only amend their initial accounting method changes using the non-automatic consent rules.

This can be particularly problematic for those taxpayers who adopted the temporary regulations and failed to make corrections to fully comply with the final regulations or who took overly conservative positions with respect to their accounting method changes given the uncertainties in the rules.

This is where Notice 2017-6 comes in. It extends the waiver of the five-year prohibition on changing prior accounting methods to comply with the final tangible property regulations through tax year 2016. So taxpayers who previously made accounting method changes to comply with the regulations can change their original method changes in 2016 by filing a Form 3115 with their timely filed 2016 tax returns. For some taxpayers, this could result in larger Section 481 catch-up adjustments in 2016 for expenses incurred in prior years.

It should be noted that Notice 2017-6 does not apply to all of the method changes associated with the final tangible property regulations. The Notice identifies the changes that it covers, which includes changing:

  • From one permissible to another permissible MACRS depreciation method.
  • The treatment of a disposition of a building or structural component or other tangible depreciable asset.
  • From expensing to deducting repair and maintenance expenses, including the identification of the unit of property.

Limited Benefit for Some Small Taxpayers

It should also be noted that Notice 2017-6 does not waive the limitation on Section 481 catch-up adjustments for small taxpayers. This limits the benefit of Notice 2017-6 for these small taxpayers.

The small taxpayer limitation was promulgated in Rev. Proc. 2015-20 (and is now incorporated into later guidance). It generally applies to taxpayers with either less than $10 million in assets or $10 million or less in annual gross receipts for the prior three years leading up to 2014.

These small taxpayers were deemed to automatically adopt the tangible property regulations as of 2014 by simply filing their tax returns without including a Form 3115 and not including a statement that they opted out of the regulations.

For these small taxpayers who did not make method changes or opt out of the regulations in 2014, Notice 2017-6 merely provides a means for going back and picking up expenses incurred in 2014-2016. These small taxpayers cannot go back and pick up pre-2014 expenses via a Section 481 catch-up adjustment, as Notice 2017-6 did not waive the small taxpayer limitation.

CONCLUSION

Taxpayers who are not subject to the small taxpayer limitation in Rev. Proc. 2015-20 should view Notice 2017-6 as an opportunity to review their prior method changes to ensure that they fully complied with the rules and to look for opportunities to unlock the tax benefits associated with their prior method changes. This will probably be the last opportunity these taxpayers will have to realize these tax savings.
Whether you or your clients performed a Cost Segregation or Fixed Asset study over the past few years, our experts will help you re-visit your current depreciation schedule and current year costs to capture accelerated depreciation or current year wright-offs before filing your 2016 tax return. Please contact Engineered Tax Services as soon as possible to consult with our experts.


*This alert is a generalized summary and is not inclusive of all tax code changes or guidance. Please review the full Internal Revenue Notice here or contact us for more details. There are nuances involved in this that are beyond the scope of this writing.

Q&A: If a condominium complex is a short-term vacation rental, can I still do a cost segregation study?

Question:
If I own and rent out a condominium complex as short-term vacation rentals, can I still do a cost segregation study?


Answer:
Yes. However, short-term rentals vs long-term rentals depreciate differently. Although a condominium is considered a residential property and typically depreciates over 27.5 years, short-term rentals typically depreciate over 39 years.
Dwelling units rented for a duration of 30 days or less are considered transient (hotel, motel, rooming houses, etc.). If 20% or more of the units, in the entire building meet this definition, the entire property is depreciated using 39 years.


Contact Engineered Tax Services here or your director to answer any questions you may have or to receive a complimentary benefit analysis.