Q: What is a Cost Segregation Study?
A: A way to reclassify building components used to operate a business such that they can provide significant tax benefits, immediately increasing cash flow.
A Cost Segregation Study is an IRS accepted asset reclassification process that accelerates tax depreciation deductions. In its most simplified form, certain parts of real estate are reclassified from 39 year or 27.5 year property into the shorter 15, 7 or 5 year property for depreciation purposes.
Since Cost Segregation Studies can recapture available depreciation from previous years and return it to the owner in the first year as a "catch up," the benefits of these studies are substantial. Cost Segregation Studies require a high degree of tax expertise combined with specialized engineering staff knowledge and compliance with strict IRS guidelines.
Q: What Are the Benefits of a Cost Segregation Study?
A: Reducing taxes and retrospectively collecting tax relief that you are due.
Some examples of the benefits of Cost Segregation Studies are as follows; A 345 room hotel costing $30,500,000, accelerated $3,750,000 in additional depreciation and reaped an additional tax benefit of over $1,300,000 in the first 4 years.
A 36 story rental building constructed at a cost of $80,000,000 experienced accelerated depreciation of over $8,500,000 and an additional estimated tax benefit of over $3,000,000.
A development of 230 townhouses costing just over $20,000,000 was able to isolate over $2,700,000 in accelerated depreciation and experience an additional tax benefit of over $1,000,000 in the first four years.
Q: How does a Cost Segregation Work?
A: Specialized engineers document every component of your building, determining which parts can be depreciated early. The results are documented in the form of a study, which the IRS accepts as justification for accelerated depreciation.
The first objective of any cost segregation study is to identify, segregate and reclassify building project related costs that are currently classified as residential real property with an asset life of 27.5 years, or non residential real property with an asset life of 39 years, to shorter depreciation lives of 5, 7 or 10 years.
When assets are classified to shorter depreciation lives, the amount of depreciation taken out each year increases. This accelerates the depreciation of the asset and consequently increases the amount of income tax deductions the entity will take on the reclassified assets.
Q: When is the Best Time to Do a Cost Segregation Study?
A: In the best case scenario, cost segregation studies should be done as soon as plans are drafted for new construction, expansion of existing construction, remodeling of existing space, or purchase of a building are completed.
The goal would be to complete the study during the construction period so that the accelerated depreciation begins the day the new or modified structure is placed in service.
However, there are a multitude of other scenarios in which a business can benefit. For example, a business that has been in operation for many years can retrospectively depreciate certain items resulting in a lump sum reimbursement from the IRS.
Q; Why Are These Studies Complex?
A: Identifying components for cost segregation can be difficult due to complex tax laws.
Cost Segregation is the result of the many tax laws that establish different asset lives and categories of asset lives that may apply to a building project. Most of these are not well known outside the cost segregation industry and consequently are not applied. This leaves the acceleration undone on large parts of the property and places it in a longer depreciation life than is allowable.
Confusion occurs when contractors combine single line item categories in the monthly draw into an undefined lump sum. There are often numerous components hidden in the one number draw request. Since they are not broken out, it is difficult to identify them for segregation to different asset lives. Change orders are also often not detailed enough, which makes it difficult to track back and determine the cost of each component.
Many times blueprints are not complete, and it is difficult to know exactly what the property consists of. Facing the daunting task of resolving this complexity, many taxpayers simply place the entire project-related construction cost into the longer 39 year or 27.5 year tax lives. Our engineers are masters at dissecting the complexities of these documents and determining the line item break outs required to segregate them into different asset lives.
Q: What Are Some Of The Largest Benefits Of A Cost Segregation Study?
A: Here are just a few of the benefits:
No increase in chances of an audit. Case law now implies "presumptive approval" if forms are filed properly and the study is done according to the IRS guidelines. Cost Segregation reallocation combined with the bonus depreciation laws for 2002-4, have a major cumulative impact
Q: What Are Some Major Areas of Cost Allocation That Can Be Accelerated?
A: Various building components used for the operation of a business, such as:
Finished Carpentry
Indirect or Soft Costs
Owner incurred costs paid outside the G C contracts
Electrical
Security & Communications Systems
Electrical for Machinery and Equipment
Decorative Lighting
Plumbing
Sanitary Drainage
Storm Drainage
Trench Drains
Exterior Gas Lines
Interior Kitchen Equipment
Grease interceptors
Site Work
Site Lighting
Exterior Decorative Lighting
Security Lighting
Pavement
Walkways and Curbings
Landscaping
HVAC
Specialty Equipment
Process Air Conditioning
Duct work for Kitchen
AC for Computer processing
Special refrigerant equipment
Wall and Floor coverings
Specialty finish woodwork
Decorative Millwork