There is an opportunity that many universities are unaware of that can provide immediate tax cash savings. If you have conducted renovations to your buildings in the past, you may be in a position to take advantage of recently released Internal Revenue Service (“IRS”) regulations. The following provides a brief background of the opportunity, outlines the characteristics of entities that can benefit, and also provides a roadmap for how to take advantage of this benefit.
What is the Opportunity?
If you have conducted renovations to your university buildings and thus disposed of assets, there could be an opportunity to benefit from these past renovations. As universities dispose of assets that were replaced in a renovation, often those disposed assets are not removed from the tax fixed asset ledger. These disposed assets are still being depreciated for tax purposes yet are no longer in service. The new regulations allow for a deduction of the carrying value of the disposed assets. The effect is that by deducting the carrying value of the disposed assets immediately – rather than continuing to depreciate these assets over longer periods of time – there is a net present value cash savings generated by the deduction.
Who Can Benefit?
Universities – specifically those who are tax-paying entities – are ideal candidates to benefit from an asset disposition deduction. Why? The key characteristics for benefiting from an asset disposition deduction are to own the property, historically conducted renovations on the property, and being in a taxpaying position. Accordingly, universities that own and thus depreciate their buildings for tax purposes will at a minimum want to consider if they could generate a cash tax savings from an asset disposition deduction in accordance with these regulations. Please note that since the university must be in a tax paying position (i.e., taxable as a for profit entity, a tax-exempt one that is subject to unrelated business income tax in relation to the respective property, or has a for profit subsidiary).
Is There a Deadline?
Yes. Taxpayers can take the asset disposition deduction for historical asset dispositions on their 2014 tax returns, but the benefit of deducting past dispositions cannot be taken for any other tax years beyond 2014 tax years. Thus, for companies with calendar tax yearends who file an extension of their 2014 tax returns, the deadline could be as late as September 15, 2015. Previously, this deduction was allowable only for the 2012 and 2013 tax years, but the latest release from the IRS extended this benefit to the 2014 tax return as well.
How do I know if it is worthwhile to take an asset disposition deduction?
In order to decide if it is worthwhile to take an asset disposition deduction for previously disposed assets, the first step is to determine whether the benefit outweighs the cost. Such a determination can be made as part of an asset disposition study. However, asset disposition studies can be both time consuming and potentially costly. Therefore, it is often more prudent to first conduct a high-level assessment (or diagnostic, if you will) to ascertain if the potential deduction is sufficient to warrant conducting a full asset disposition study.
Asset Disposition Diagnostic
The next questions are how is a high-level assessment or diagnostic conducted and what type of information is required? The information required is relatively basic and typically readily available:
- A tax fixed asset ledger; and
- High-level building specifications: year built, wall construction type, total square feet (by floor and in total), number of stories, and roof type (i.e. gravel, tar, pitched, etc.). Any readily available summary of past renovations/repairs is helpful as well.
The first step in determining if there are assets that are no longer in use but still being depreciated for tax purposes is to conduct a “trend analysis” on the fixed asset ledger. The trend analysis estimates how much it would cost to replace the entire building today, based specifically on the cost to replace the assets that are contained on the fixed asset ledger. Since the analysis is based specifically on the fixed asset ledger, it ignores whether or not all of the assets are actually still in use. In other words it captures “ghost assets” that are no longer in use but are still on the fixed asset ledger and being depreciated for tax purposes.
The second step is to estimate how much it would cost to replace the entire building based on factors unrelated to the tax fixed asset ledger, as mentioned above (i.e., year built, number of stories, etc.). Once this information is gathered, relevant cost estimates can then be applied to estimate the cost to reconstruct the building. This approach measures the cost to rebuild the structure without any regard to the assets contained on the fixed asset ledger, thus the cost to replace the entire building excludes any assets that were previously disposed of but still remain on the fixed asset ledger (i.e., it excludes any “ghost assets”). The results of these two steps are then compared. For example, if the cost to reconstruct the building in step one (based on the fixed asset ledger) is $25 million, while the cost to reconstruct the building in step two is $20 million, the diagnostic indicates that there could be $5 million in replacement costs of assets that have been disposed of but are still present on the fixed asset ledger. As the deduction is based on the carrying value of the disposed assets rather than the cost to reconstruct the building, a bit more analysis is typically warranted. For example, disposed assets that have a short remaining useful life would have a much lower carrying value, thus an examination of the estimated age of the disposed assets offers additional insight, etc. Utilizing readily available information, the diagnostic provides a very useful directional assessment as to the reasonableness of conducting a full disposition analysis, without expending much cost or effort.
Full Asset Disposition Study
Assuming the results of the diagnostic indicate that it would be beneficial to conduct a full disposition study, the focus turns to what a full asset disposition study entails and what information is required. The key aspects of a full disposition study include:
- Analysis of past renovations and repairs, focusing on the specific costs incurred and the nature of the renovations and repairs;
- Identification of the assets that have been disposed of but are still being depreciated on the tax fixed asset ledger;
- Estimation of the carrying value of the assets that have been disposed of, and thus can be deducted for tax purposes; and
- Preparation of a narrative report and schedules that provide supporting documentation for the deduction associated with assets that are still being depreciated but have been disposed of. To ensure an efficient approach, the following steps should be implemented when conducting a disposition analysis for each building: Conduct a site inspection;
- Review construction drawings, cost information and available blueprint sets;
- Analyze the history and nature of the various renovations and repairs at the property;
- Review and categorize contractor and supplier invoices to determine detailed cost schedules associated with renovations and repairs. This is used in preparing the appropriate documentation for identifying assets that were replaced and thus disposed of previously;
- Estimate the cost to reconstruct the building that was part of the original acquired property, as well as the cost of all replacements and renovations. This provides an estimate of the portion of the original property that was replaced and thus disposed of; and
- Estimate the carrying value of assets currently being depreciated that should instead be deducted.
Example: Full Asset Disposition Study
For illustrative purposes, consider the following example of a university that was able to deduct the carrying value of assets that were disposed of previously. The university made numerous renovations over the years, including work on the roof, central areas, classrooms, etc. In each case while they capitalized the costs associated with the new assets, they did not remove the assets that were replaced from the tax fixed asset ledgers. The assets that were disposed of as part of the renovation were identified.
The cost to reconstruct the disposed assets and all assets was then estimated, with the method applied dependent on the availability and condition of the fixed asset records, documentation of renovation costs, etc. This resulted in a proportion of the cost to replace the disposed assets to total assets. As this reflects the costs to reconstruct the building, the proportion was then applied to the carrying value of the total assets, to determine the amount that should be deducted for tax purposes related to ghost assets, thus resulting in a reduction in the companyâs current cash tax liability.
This is actually a straightforward example, and the complexity can increase significantly in circumstances where there have been multiple renovations, data regarding the original assets and / or renovation assets are unavailable, etc. It is worth noting that even under what may appear to be difficult circumstances regarding the availability of data, there typically is a reasonable approach that can be taken to ascertain a measurable and supportable asset disposition deduction.
With a short window of time that ends with filing deadlines for 2014 tax returns, universities who depreciate their assets for tax purposes and have conducted renovations in the past could realize a significant cash savings by taking tax deductions for previously disposed assets. As detailed disposition studies can become costly (depending on the number of buildings, size and type of structures, condition of records, and history of repairs and renovations), conducting an initial high-level assessment or diagnostic provide a practical way to gain insight into the potential financial benefits of a full asset disposition study.
Philip Antoon is managing director with global professional services firm Alvarez & Marsal. He can be reached at [email protected]. Mark Young is a managing director with Alvarez & Marsal Taxand. He can be reached at [email protected].
