If your client owns developed real estate valued at $1M or more, you may be in a position to help them realize significant tax savings and an increase in cash flow through a cost segregation study (CSS), i.e. component depreciation studies.

CSS have become an increasingly valuable but not commonly understood tax strategy that should be considered by virtually every CPA whose client owns, is constructing, rehabilitating or acquiring a real estate facility. Absent a CSS, newly constructed or purchased property often yields only modest depreciation deductions, leaving unrealized tax benefits on the table. Cost Recovery Solutions, LLC (CRS) can maximize inherent tax benefits for a client by identifying, classifying, and segregating components of a building into personal property and land improvements rather than real property in order to place them in shorter MACRS depreciation categories.

Although the use of CSS studies is becoming more widespread, there are still many clients who have never been introduced to the concept. Most CPA firms do not have the engineering or architectural experience required by the IRS to perform a CSS. The CRS-Alliance team will work with your firm to create goodwill and substantial tax savings for your client.

Our Qualifications

The CSS should be performed by an organization that provides a blend of in-house knowledge of engineering, architecture, tax and accounting. This 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). CRS can provide this combination.

We have performed projects in all corners of the United States and have experience with a wide variety of asset types. Projects recently completed include office, retail, commercial, industrial, manufacturing, apartments, hospitality and many others.

Not only do we prepare the studies but we also look for opportunities to educate the CPAs and building owners in all matters related to depreciation. Jerry Kootman, our Managing Tax Director, has over 30 years experience in providing tax and accounting advice so you can be sure your financial interests are always considered first.

We have published many articles on cost segregation and are frequently invited to lecture or provide CPE for the industry.

How is the study performed?

The CSS 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/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 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 the components. The components are then priced out using standard construction cost data such as RSMeans Building Construction Cost Data and Marshall Valuation Service.

Some examples of assets that have qualified for accelerated depreciation include certain floor coverings, finish millwork, accent lighting, intercom and security systems, specialized electrical and HVAC, moveable wall partitions, and land improvements including parking lots, fencing, outdoor lighting and landscaping.

The Report

The Report includes the project background, asset classifications, asset descriptions, allocated related fees and services, spreadsheets segregating the assets, references to tax court cases, revenue rulings and tax citations. CRS is happy to provide a copy of a sample report upon request.

Is cost segregation a complicated, risky method? Will it increase the chances of my client being audited?

No. And, no. The IRS has published step-by-step revenue procedures detailing how this method can be utilized. We will work with you every step of the way to make sure you file an accurate and supportable report with your annual tax return. Also, keep in mind that the "Change in Accounting Method" form you file acknowledges that you are simply making a change in accounting procedures, not a change in accounting method.

A Brief History

Cost segregation studies began during the 1980's as a means to help developers of new property obtain special investment tax credits for personal property contained in the buildings. The elimination of investment tax credits (ITC) in the 1986 tax law overhaul appeared to eliminate the benefits of cost segregation studies. However, the Tax Court ruled in 1997 that property qualifying as tangible personal property under former ITC rules would also qualify in the same manner for purposes of federal income tax depreciation.

In 1997, the US Tax Court ruled in favor of Hospital Corporation of America (HCA), that property qualifying as tangible personal property under the former ITC rules would also qualify for purposes of federal income tax depreciation. HCA is considered a landmark decision for owners of commercial properties.

In 1999, the IRS released Legal Memorandum 19921045 in which the IRS agreed not to contest the HCA reclassification of building costs into different asset categories that result in shorter depreciation lives. Additionally, this legal memorandum directs agents to verify that an engineering or architectural study has been done to identify portions of the building's system not related to the operation and maintenance of the building. Without these detailed studies, IRS agents are advised to NOT accept the reclassifications.

Recent Legislative Update

During 2002, legislation was passed providing tax benefits for business owners on newly constructed or renovated properties post September 10, 2001. This provision, commonly referred to as the "Bonus Depreciation” allowance, may allow business owners to take an additional 30% depreciation deduction in the first year. The more recent 2003 Tax Act change established a first year depreciation "bonus" equal to 50% of the cost of qualified property acquired after May 5, 2003 and before January 1, 2005, and placed in service before the later date. In addition, the property must be subject to MACRS and have a recovery period of twenty years or less or be a qualified leasehold improvement property. Other requirements and exceptions apply. A cost segregation study by its very nature reallocates property to a life of twenty years or less and thus allows the owner to capitalize on this recent tax law benefit. Although Bonus Depreciation expired at the end of 2004, you can still retroactively claim the depreciation that you were eligible to obtain for assets placed in service in the specified time frame.

Another development is under Revenue Procedure 2002-19, which reduces the four-year period to deduct the unclaimed additional depreciation on property previously placed in service to one year. Our studies can provide a business owner the opportunity to reclaim depreciation on existing property.

Additional Areas of Savings

Pre-Construction Tax Planning
Dramatic cost savings can be realized through pre-construction tax planning, where the specialist meets with the architect and general contractor to explain how design decisions can affect the depreciation classification of costs, thus resulting in a more effective cost segregation study.

Fit-Up of Commercial Space
Tenants and landlords often share in the fit up of commercial space. A detailed engineering analysis can segregate items into personal property components that have shorter depreciation class lives so that both the tenant and landlord benefit.

How do you get started?

We believe that anything that brings a competitive edge to a competitive environment is beneficial in building relationships with your clients.

CRS will discuss with you the effectiveness of CSS as a tax-planning tool for your client. We will provide cost segregation proposals for your client at no cost, so that you may objectively evaluate its benefits to them.

Our straight-forward, one-page questionnaire allows us to gather enough information to provide you and your client with an estimated tax savings. Clients routinely receive present value cash flow savings at 10 to 20 times their investment for the study.

Let us work together to demonstrate to your client how we can make a considerable improvement to their bottom-line. Why should your client pay any more in federal and state taxes than they absolutely have to? Don't delay. Call Jerry Kootman, CPA at (732) 548-3855 to determine which properties may qualify for a CSS.