LMSB Directive Focuses on Cost Segregation in Biotech/Pharmaceutical Industry

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.¹

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.

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 either Louis Milano, Technical Advisor, Pharmaceuticals at 908-301-2106, Robert Lento, Engineering & Valuation Group Manager at 908-301-2129, Milton Pagan, SBSE Senior Program Analyst at 619-615-9583, or Ardell Mueller, Senior Program Analyst, Retailers, Food, Pharmaceuticals and Healthcare Industry at 630-493-5946.

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 1/1/06.

 Asset

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 1/1/06.

0.03 -- Land Improvements but see Note 2 for exceptions