It really is quite simple. IRS acquiesced to a lawsuit brought by HCA in Hospital Corporation of America v. Commissioner, 109 T.C. 21 (1997)(“HCA”). In HCA, the Service took the position that certain property items were structural components of a building. They also argued that Sec. 168(f)(1) prohibited the use of a component depreciation method for computing depreciation on buildings (including structural components). They argued several other points against HCA as well. However, the presiding Judge Wells ruled that the property at issue was Sec. 1245 property and rejected the Service’s argument. His decision was based on Treas. Reg. Sec. 1.48-1(e) denying the IRS’ assertion they were inapplicable following the enactment of ACRS in 1981. Judge Wells concluded that the enactment of ACRS did not redefine Sec. 1250 property to include property that had been Sec. 1245 property for purposes of the Investment Tax Credit (ITC). In effect, the HCA ruling reinstated a form of component depreciation for certain building support systems. These include systems such as electrical and plumbing systems that directly serve tangible personal property. There are, of course, many more systems and components qualifying for reclassification using cost segregation.
Considering the IRS has now tacitly endorsed cost segregation by their acquiescence, isn’t it time to take advantage of their generosity? Consider this. As a physician seeking to build significant retirement income, doesn’t it make sense to use every available tax strategy at your disposal? In fact, cost segregation doesn’t only accelerate depreciation. Cost segregation increases cash flow significantly in the first six years of medical office building ownership. The extra cash flow helps cover the unexpected expenses of managing a medical office building. Unexpected expenses such as roof leaks, sewer backup, and electrical system failures can require additional out-of-pocket contributions from doctor partners in medical buildings. Cost segregation also helps reduce real estate taxes on the medical building. Tangible personal property requires lower property tax fees and thus decreases monthly operating expenses.
Many physicians and physician groups who invest in their own medical building, and other opportunities as well, rely on their financial experts (CPA, tax attorney, etc.) for direction. Cost segregation is a term many are unfamiliar with or don’t have direct experience in. According to the IRS, applying cost segregation requires, “…personnel competent in design, construction, auditing, and estimating procedures relating to building construction.” This conclusion was expanded in Private Letter Ruling 7941002.
This in no way impugns CPAs or tax attorneys; on the contrary, it merely sheds light on why so many investors are unaware of cost segregation and it’s benefits.
Cost segregation, when applied properly, will accelerate 30%, or more, of medical office building’s assets into 5- and 15-year classifications. The 5-year class is considered tangible personal property under IRC Sec. 1245. The 15-year class is considered land improvements and can be considered under both IRC Sec. 1245 and 1250, depending upon the circumstances.
For example, a doctor purchases a medical office building for $5,000,000. A cost segregation study reallocates 30% to short-life asset classes. The accelerated depreciation would be over $1,000,000. Most physician’s find themselves in the 35% income tax bracket. The result is an additional $350,000 in federal income tax credits applied to the initial 6 years of ownership. As an investor, would an extra $350,000 impact your bottom line? In fact, the extra cash flow will help the savvy investor negotiate lower bank rates.
Additionally, if the doctor is building a new medical facility, cost segregation delivers more. By applying cost segregation “pre-construction” many assets can be designed and built differently. This difference changes the asset from the normal Sec. 1250 category to Sec. 1245. Thus, cost segregation actually can “create” 5- and 15-year assets before constructed. Now, that same medical building with 30% reallocated to short-life classes may have upwards to 50% or more!
More and more physicians are applying cost segregation to their new construction projects and medical office building purchases. Cost segregation benefits the doctor by putting cash in your pocket.
Cost segregation delivers results every time it is applied.
For more information on applying cost segregation to your facility, contact us: