A study in tax savings

By partaking in a cost segregation
study, your company can recognize
significant tax savings in real, permanent dollars. Although the overall concepts
have existed for some time, certain court
cases and rule simplifications have made
cost segregation increasingly popular.
Also, the green movement in construction
and recent tax law changes like the
Economic Stimulus Act have added additional considerations.

“A large percentage of the companies we
meet with move forward with cost segregation,” says Peter A. Bellini, CPA, a principal at Skoda Minotti, a Cleveland-based
firm of CPAs and business and financial
advisers.

Smart Business spoke to Bellini about
how cost segregation identifies, segregates
and reclassifies the physical assets of your
business that qualify for shorter, depreciable tax lives.

What is cost segregation?

Cost segregation is an IRS-approved
method of reclassifying components and
improvements of a commercial building
from real estate to personal property. The
process allows the assets to be depreciated
on a five-, seven- or 15-year schedule
instead of the traditional 27.5- or 39-year
depreciation schedule of real property. The
results will greatly reduce a company’s taxable income and increase its cash flow.

IRS rulings over the past several years
and administrative changes have allowed
taxpayers to take advantage of these previously understated depreciation expenses
on property already in service by utilizing a
change in accounting methods that no
longer requires the need to amend tax
returns. New construction, buildings purchased in the current year, or any building
placed in service after 1986 are eligible.
Substantially large lease-hold improvements are also eligible.

What does a cost segregation study do, and
how can it help a business?

Cost segregation uses an engineering-based study and analyzes construction
documents, blueprints, invoices and other
relevant information to determine which
components of the facility can be depreciated over a shorter time period.

As instructed by the IRS Code, commercial real property must be depreciated
over 39 years. Many of the components
can be classified as personal property and
depreciated over five, seven or — in the
case of land improvements — 15 years. By
depreciating personal property and land
improvements over shorter lives, a company is able to recognize significant
deductions and tax savings on its current
and future tax returns.

What qualifies for a shorter depreciation?

Cost segregation studies the components of real estate, separating out personal property that qualifies for a shorter
depreciation life, including equipment,
machinery, computers, carpeting, cabinetry, special lighting, generators, landscaping, parking lots, windows, site
preparation, razing of an existing structure, cabling, subfloors and much more.

What do you need to get started?

It’s very easy for companies to obtain an
initial cost analysis and an estimate of savings. If it’s an existing structure, the cost
segregation specialist will need a description of the building, capitalized costs and
current depreciation schedules. In the case
of new construction, the developer or
investor group usually works directly with
the specialist near the end of construction
to analyze construction costs, blueprints
and specifications. Eventually, construction invoices, depreciation schedules,
appraisals, a site inspection and photographs of construction components also
will be needed.

How have recent tax law changes affected
cost segregation?

Beyond tax refunds to individuals, there
was one substantive pronouncement of the
Economic Stimulus Act of 2008. It altered
Section 179 to increase ‘immediate depreciation expensing’ to $250,000 per year
from $125,000 and to restore a 50 percent
bonus depreciation. Those new pronouncements only apply to new construction and new, major remodeling.

But, what they do is enhance the value of
implementing a cost segregation program.
If you’re doing a major remodel or constructing a building this year, you would be
absolutely remiss if you didn’t perform a
cost segregation study. It would be a major,
major oversight.

How has the green movement in construction
affected cost segregation?

Organizations today are being more environmentally conscientious, even though
the materials for ‘green’ buildings are more
expensive. But, if you go down that path,
there are more components that qualify for
shorter depreciation lives, like solar-energy
panels. I should mention that other tax
credits not pertaining to cost segregation
are also available if you build green.

PETER A. BELLINI, CPA, is a principal in the tax department at Skoda Minotti. Reach him at [email protected] or
(440) 449-6800.