CATEGORIES

Categorized | Finance and taxes, Taxes

Saving with cost segregation

Why you may be overpaying your federal taxes every year

By Brent Ross

Countless numbers of commercial property owners overpay federal taxes every year and are missing out on allowable depreciation expense deductions. Under existing IRS tax law, accelerated depreciation expense deductions are available to all federal taxpayers; however, without an engineering-based cost segregation analysis, the taxpayer is unable to take full advantage of the tax law and, therefore, surrenders significant cash flow to the IRS.

What is cost segregation?

A typical cost segregation study maximizes the tax benefit of real estate ownership by identifying, segregating and classifying a building’s components to asset categories with the shortest possible life creating significant tax deductions sooner for federal and state income tax purposes.

This is determined though an analysis that reclassifies components of a building from 27.5, 31.5 and 39 year depreciable lives to five, seven and 15 year depreciable lives. The benefit comes from accelerating the depreciation tax deductions, which are more valuable today than 39 years from now.

Nonstructural items like carpet, accent lighting and signage, or exterior items such as paving, sidewalks and landscaping are examples of building components eligible for accelerated depreciation, and are items that can be “broken out” from structural costs and depreciated over a shorter period.

Many property owners can identify nonstructural items that qualify for accelerated depreciation, but the greatest savings come from identifying assets in three broad areas: electrical, mechanical and plumbing.

Let’s say a standard office has three electrical outlets. To effectively operate your computers, printers, projectors, etc. in your office, however, you require six electrical outlets; those “extra” three outlets may qualify as five-year property and accelerated depreciation. The same can be said for specific air conditioners when a certain temperature must be maintained for the safety of the product, such as in grocery/food stores or maintenance facilities so equipment won’t overheat.

Depreciation can increase your ROI

An often overlooked tax-saving opportunity is accelerated depreciation of cost associated with the construction, renovation or purchase of a new building or real estate. Taking advantage of certain techniques can boost your return on investment (ROI), and a cost segregation study can help you improve profitability and increase ROI by maximizing tax benefits on certain projects.

Property owners can substantially reduce taxable income and maximize current depreciation by accelerating deductions, thereby increasing after-tax cash flow. In addition to recently purchased or constructed properties, a cost segregation study can produce substantial tax benefits for properties that have already been depreciated for as many as 10 years or more by catching up on missed depreciation.

Most business owners who own a building understand that they recover their investment through depreciation. What they may not understand is how to look at an entire facility and allocate as much cost as possible to things with the shortest depreciable life thereby recovering the cost of their investment for tax purposes much sooner.

Business owners often overlook the opportunity to allocate costs to land improvements and things that qualify as furnishings that depreciate in five to 15 years as opposed to the building itself, which depreciates over 39 years for commercial property and 27.5 years for residential rental property.

A proven and allowable tax strategy

Cost segregation is by no means an aggressive or risky strategy. For decades, court rulings havesupported the practice of segregating costs for tax depreciation on commercial buildings. In 1997, the U.S. Tax Court ruled that segregating costs for tax purposes was allowable. Subsequently, cost segregation has become an accepted—if somewhat underutilized—tax planning strategy.

Using sources such as revenue rulings, court cases, IRS publications, senate and congressional finance committee reports and IRS regulations, cost segregation experts are able to help companies apply deductions that create tax savings starting in the first year.

Is a cost segregation study for you?

Office, manufacturing, retail, professional, residential rental—it doesn’t really matter which type of real estate you are building or acquiring. If the property can be depreciated, a cost segregation study would be a valuable strategy. The study can help you find hidden deductions and help you realize substantial tax savings. Even if your real estate project has been completed for several years, the IRS allows for a look back of the benefits from previous years through a change in accounting method.

A cost segregation study requires detective work. It might start with an invoice, but it goes into extensive analysis involving the examination of construction documents, blueprints and an inspection of property. This approach analyzes both actual cost records and cost estimates and may take up to a month to complete. Trained engineering and tax specialists will work closely with you and your contractor to identify more assets that qualify for shorter depreciable lives and accelerated depreciation, including all assets that are imbedded in your building’s construction or acquisition costs.

The business owner receives a detailed report including background, the methodology, asset classification summary and support, and the complete allocation of costs—everything they would ever need to know about the process and results.

Reinvest in your company

It’s important for the property owner to have a detailed report from a CPA so they understand exactly what they did. The engagement will pay for itself many times over through the first year’s tax savings. Earning these tax savings now, as opposed to many years from now is valuable. The property owner can take that money and invest it back into their business.

It’s important however, for property owners to work with engineers and tax advisors that are intimately familiar with cost segregation rules and requirements in order to make sure the study is in compliance with the constantly changing regulations regarding how assets may be classified. Any building put into service after 1987 qualifies. Even now, years later, the benefits can be realized.

The money you save from a cost segregation study can help your company in many ways. It could for example be used as additional working capital for operations, or be used toward new investments and ventures or used to pay down debt and reduce interest costs.

Brent Ross, CPA, is president of Brent Ross & Associates, CPAs, LLC. He has worked in the area of federal and state taxation since 1972. Having worked as a practicing CPA since the early 1970s, he has extensive experience dealing with issues related to investment tax credits (ITC) and property qualifying for ITC and component depreciation. This body of experience is the backbone of knowledge necessary to complete quality cost segregation analysis and reports to owners. He can be reached at 904-448-6408, bross@brjaxcpa.com, or through http://rosshughescpa.com/

Who qualifies?

Although any non-residential commercial property may qualify for tax deferral and increased cash flow, here is a sampling of the types of properties with a high probability of benefiting from a cost segregation study:

Corporate office buildings

Warehouses and distribution centers

Hospitals

Medical/dental offices

Nursing homes

Apartment buildings

Restaurants

Hotels and motels

Strip malls and retail stores

Car dealerships

Golf courses and country clubs

Grocery stores

Airport hangers


Leave a Reply