A cost segregation study is the process of identifying fixed assets and their costs and classifying these assets and costs to maximize federal income tax depreciation deductions.
It involves reclassifying some of a building’s costs, presumed to be subject to a 39-year cost recovery life, into shorter personal property or land improvements, now with a five- or seven-year rate of depreciation for personal property and/or a 15-year rate for land improvement projects.
With engineer-based cost segregation, a building owner may depreciate a new or existing facility in the fastest allowable time, accelerating the owner’s tax depreciation and tax deduction and deferring income taxes.
Smart Business spoke with Lou Petro, senior manager at Cendrowski Corporate Advisors LLC, regarding the benefits of performing a cost segregation study.
What facilities are available for a cost segregation study?
Cost segregation studies are economically viable for almost any commercial facility. The facility may be newly acquired or constructed, under construction, inherited or a property upon which a full cost segregation study has never been performed.
Applicable facilities include apartment buildings; breweries; car dealerships; banks; distilleries; grocery stores; health care facilities; hotels and motels; laboratories and research facilities; and manufacturing facilities. The list also includes office buildings, resorts, restaurants, retail malls, warehouses and wineries. In essence, any depreciable real property used in a taxpayer’s business would be suitable for a study.
How much can a cost segregation study save?
Typically, the present value of a taxpayer’s cash flows is increased by about 20 cents for each dollar reclassified out of a 39-year property. In a typical cost segregation study, between 15 and 45 percent of a building’s costs can be reclassified to shorter life assets.
The percentage depends on the type of facility and on such things as special use or process equipment, interior finishing and land improvements. For newly constructed property, the bonus depreciation allowance allows the deduction of up to 50 percent of qualifying shorter life asset costs, which accelerates the tax savings extensively.
Who would perform a cost segregation study?
The Internal Revenue Service requires that cost segregation studies be engineering-based.
The IRS Cost Segregation Audit Techniques Guide states, “Preparation of cost segregation studies requires knowledge of both the construction process and the tax law involving property classifications for depreciation purposes.”
In general, a study by construction engineers is more reliable than one conducted by someone with no engineering or construction background. Experience in cost estimating and allocation, as well as knowledge of the applicable tax law, are other important criteria.
How would a taxpayer choose a firm to perform a cost segregation study?
A taxpayer needing a cost segregation study should use a firm that has the qualified personnel and expertise in place to perform an engineering-based study.
Generally, such a firm would have experience with this kind of work and could assist you through the process and answer any questions that might come up along the way.
A combination of registered professional engineers and tax-qualified CPAs would be appropriate for the work. The firm, in general, would provide a potential client with a fixed-fee proposal for the cost segregation work.
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