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Hotel Owner’s Expansion Denied Bonus Depreciation Under Safe Harbor Rules



In a memorandum released January 10, 2014, the IRS denied a hotel operator bonus depreciation on construction costs related to the renovation and expansion of its hotel complex.


A taxpayer engaged an unrelated architect and contractor to design and provide construction services for a hotel construction project. As portions of the project were completed, an application for payment was submitted to the taxpayer. Payment was then made by the taxpayer in accordance with the contracts and title for the work passed to the taxpayer. This process continued over the term of the project, which spanned multiple years.

The issue in this case was whether the taxpayer met the burden of proof to support the costs treated as qualifying for bonus depreciation and when those costs were incurred.

The taxpayer had a cost segregation study performed. In Year 6, bonus depreciation was claimed on the project. The claim stipulated that the construction contract was a “turnkey” contract and completion did not occur until all work was completed and accepted by the taxpayer. The taxpayer claimed that, because final completion and acceptance did not occur until Year 6, no costs were incurred until that time. Consequently, the project met the requirements of the Internal Revenue Code and the “10% safe harbor” rule (physical work of a significant nature does not begin until more than 10% of the total cost of the property is incurred) of the Treasury Regulations.

The IRS disagreed and raised two issues:

  • The contractor, in this case, did not serve as the developer, designer, and contractor for the project.
  • Title to the project was not transferred to the taxpayer upon its final completion. Instead, it was transferred over time.

Because of these issues, the contract was deemed to be a “design-bid-build” contract and the project was not “turnkey.” All costs were not allowed to be included in Year 6 for purposes of the 10% safe harbor regulations.

The IRS further applied the “all events” test and economic performance requirements of the Code to determine when the costs could be incurred for bonus depreciation purposes. It found that the project pay applications and the cost segregation study used as support did not “…clearly indicate when the costs of any separately identifiable properties were incurred.” Specifically, as the pay applications were not broken down to the individual properties, it could not be possible to determine when the total costs of separate properties that could be qualified properties were incurred. Thus, the taxpayer was unable to prove which costs were incurred after December 31, 2007 under the safe harbor rules to qualify for 50% bonus depreciation.

What Does CohnReznick Think?
Hotel operators should review the facts of this case to determine if positions they have taken with respect to bonus depreciation on expansions are supportable. Additionally, they should consider conducting comprehensive cost segregation studies, in light of the facts in this case, to maximize potential depreciation deductions.


For more information, please contact one of the following CohnReznick professionals:

  • Marshall Varano, Partner, at 858-300-3424
  • Gary Levy, Partner and Hospitality Industry Practice Leader, at 646-254-7403

To learn more about CohnReznick’s Hospitality Industry Practice, please visit our webpage.


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