What if you purchased or built your building several years ago?
The good news on this issue is that even if a study is done in a year subsequent to the construction or purchase of a building, the taxpayer is able to catch up the depreciation expense on the tax return for the year in which the study is done. This gives the taxpayer a huge deduction in the year of the study, and the ability to use the quicker depreciation method over the remaining useful life of those assets. This catch-up depreciation expense will reflect the total depreciation deduction over the years as if it was done from day one.
To build on the previous example, assume all facts are the same except that the cost segregation study was done in the sixth year of owning the building. The taxpayer can take a total depreciation deduction of $73,000 ($33,000 (annual depreciation) + $40,000 (catch-up depreciation)) in that year. The $40,000 catch-up in depreciation is calculated by comparing the depreciation to date using the study ($165,000 ($33,000 x 5)) to that not using the study ($125,000 ($25,000 x 5)).
Why do you need experts to do a cost segregation study?
Some people will think, ‘I can estimate the portion of the total building cost that qualifies from my blueprints and cost reports, so I’ll just depreciate those quicker.’ The IRS has made it very clear that, for these pieces to be pulled out and to get the study’s benefits, you need an engineer-based report to support the speed up of depreciation.
Are tax savings the same on every building?
You have to consider many factors (i.e. size, finished space and purpose) of the building to determine the potential for tax savings. A warehouse would have the least potential; with just four walls there isn’t as much to be depreciated quicker. If that warehouse has an office within it, there is more potential as the office portion would have more separable items. Going to the extreme, if you have a manufacturing or medical facility, there is a lot of potential there. They not only have more finished space, but they have specialized areas that can be depreciated quicker in those facilities.
If I do a cost segregation study, am I more likely to get audited?
A cost segregation study doesn’t raise any red flags with the IRS. At this point, they have seen many of these studies. The study alone won’t raise a red flag, but other things might. You want that cost segregation study in your files to support those deductions.
How can businesses know if they qualify for a cost segregation study and if it will be cost-beneficial?
Every building is unique. But usually, buildings valued at $500,000 or more typically see a net present value of tax benefits compared to cost that would make the cost segregation study cost beneficial. Your CPA should be able to conduct a free feasibility study to help you quantify the amount of tax savings you could receive and determine if any obstacles may prevent you from realizing the full effect of the increased tax deductions. Comparing the amount of tax savings to the cost of the study will help you make a decision.
David R. Walter, CPA, MBA, is a manager with Skoda Minotti. Reach him at (440) 449-6800 or [email protected].
