What is Cost Segregation?

Cost segregation improves cash-flow and bottom-line for building owners

Cost segregation studies (CSS) have become an increasingly valuable but not commonly understood tax strategy that should be considered by virtually every taxpayer who owns, is constructing, renovating or acquiring a real estate facility.

Its tax benefits can be applied to various types of real estate: apartments, assisted living/nursing homes, auto dealerships, office buildings, hi-tech facilities, hotels/motels/resorts, manufacturing facilities, medical buildings, restaurants, retail space, warehouses and others.

What is Cost Segregation?

Cost Segregation is an engineering-based approach to identifying assets within a building that can be reclassified into a much shorter depreciation class than the building itself. Real estate properties (and everything in them) are generally depreciated using a straight-line method over 39-years (27.5-years for residential properties). These properties are defined as real property.

Cost Recovery Solutions (CRS) can maximize your inherent tax benefit by identifying, classifying, and segregating the personal property components of the building, resulting in depreciable lives of 5, 7 and 15 years using accelerated depreciation.

Who can benefit from Cost Segregation?

To determine if a cost segregation analysis is appropriate for you, ask yourself the following questions: 1) Is the cost of your building (land excluded) at least $1M? 2) Have you purchased, constructed or renovated any property in the past 12 years? 3) Do you plan on retaining your property for at least the next few years? 4) Do you have net income that is currently taxed?

Cost segregation is a valuable service if you can answer "yes" to these questions.

How is the study performed?

The process is in-depth, but non-intrusive. The cost segregation specialist uses an engineering-based approach, as specified by the IRS. Their job is to examine architectural and engineering drawings for potential asset reclassification. A physical inspection may also be performed, if necessary. Cost data including the contractor's application for payments, change orders, owner incurred cost and disbursements are examined. Direct labor, material components and indirect costs are allocated based on an analysis of drawings and specifications.

An existing property without the above documentation requires a different approach. The specialist must become familiar with the purpose and major functions of the property. Then a full analysis of the property is conducted, including inspection, photographs and measurements. This allows the specialist to reconstruct the property on paper, including all components. The components are then priced out using standard construction cost data such as RSMeans Building Construction Cost Data and Marshall Valuation Service.

How much can be saved?

The average net present value of additional cash flow is $200,000 for every $1,000,000 of 39-year property that is reclassified. Typically between 15-40% of a building's overall costs can be reclassified to one of the shorter cost recovery periods. The actual amount of present-value savings depends on the type of property and its specific construction components. You can receive a free estimate of benefits for your project by filling out the appropriate form.

Who can perform a cost segregation study?

The IRS requires that a CSS be "performed by 'qualified' individuals or firms, such as those employing … personnel competent in design, construction, auditing, and estimating procedures relating to building construction." Our team approach will result in a study that maximizes the tax benefits of the study, while conforming to IRS regulations and appraisal guidelines of The Appraisal Foundation (USPAP) and by the American Society of Appraisers (ASA).

Our specially trained engineers have many years of experience in performing cost segregation analyses. They are well versed in the IRS requirements and use this knowledge as the framework for our projects.

IRS supports cost segregation

Although cost segregation has a long history, the basis for today's studies were established by a US Tax Court decision in 1997.

In the past years, the IRS has continued to validate, uphold and improve the value of cost segregation studies by enacting the 2002 and 2003 Tax Acts.

For those that should conduct a retroactive study, the IRS now allows the benefits to be recognized in one year, rather than over four years – without filing an amended return or without IRS approval.

The IRS has recently published Revenue Procedure 2004-11 which verifies that the taxpayer does not need to obtain approval or file amended returns to perform a retroactive CSS.

How do I get started?

CRS provides proposals at no cost, so a building owner may objectively evaluate potential benefits. Do not assume that your CPA has performed a cost segregation study in conjunction with the filing of your annual tax returns or that it's too late to file one for your existing building.

Ask your CPA if an analysis has been performed on your property. If not, discuss getting a cost segregation specialist involved on your team.

Why should your company pay any more in federal and state taxes than it absolutely has to? Well, we believe that is nobody's business but YOURS. Don't delay. Call Jerry Kootman, CPA or Rob Rahner, ASA, CFA at (732) 548-3855 to find out if your property qualifies.