COVER STORY, JULY 2009
COST SEGREGATION FOR CASH AGGREGATION
With a cost segregation study, see if that hard-to-find operating capital may be hidden in your building.
Commercial property owners may end up paying Uncle Sam a lot less in taxes if they explore cost segregation. They can begin to realize those tax reductions and the resultant increased cash flow as soon as their next quarterly estimated tax payment.
Under provisions in the 2009 American Recovery and Reinvestment Act, property owners who decide to commission a paid, engineering-based cost segregation study could possibly receive a refund on taxes paid during the last 5 years. Your tax preparers may now apply the net operating loss created by the cost segregation study to past tax bills and get a refund on taxes paid as far back as 2003.
What is Cost Segregation?
In typical accounting practice, 100 percent of a building’s costs are depreciated on a straight-line basis in 39 years. Yet, according to the IRS, many components of a building — and most land improvements — have shorter depreciation lives. Cost segregation allows property owners to reduce their current tax bills by identifying and correctly depreciating those assets more rapidly.
Industrial buildings, from warehouses to manufacturing plants, whether purchased or constructed, will have different percentages of construction-related costs that can be reclassified from 39-year depreciation to 5-, 7- and 15-year depreciation lives for federal and state income tax purposes. Sometimes as much as 60 percent of a manufacturing facility’s cost, which could be cost segregated, is incorrectly buried in the “building” line of its depreciation schedule and being depreciated on a straight-line basis across 39 years.
To correctly itemize the components with shorter depreciation, industrial property owners can hire a cost segregation firm. These firms conduct an onsite review and then take the total purchase price (minus the land cost) or the total construction cost (including soft costs) and separate (“segregate”) individual building components and their associated costs into correct, shorter depreciation lives of 5, 7 or 15 years. Of course, they must do this in a way that will meet IRS guidelines.
Can My Accountant Do This?
The IRS Cost Segregation Audit Techniques Guide provides that this kind of study be performed by “qualified” individuals or firms, such as those employing “…personnel competent in design, construction, auditing and estimating procedures relating to building construction.” Cost segregation firms also have to keep current with the relevant IRS regulations, rulings and court cases to insure that they are maximizing the benefit to their client while staying within all IRS guidelines.
While your accountants may not meet the “qualified” test applied by the IRS, they will be the people to apply the results of the cost segregation study to your tax return. Your cost segregation firm should have the CPA and tax attorney expertise to answer any questions raised by your accountants.
What Else Can Be Done With a CS Study?
Accountants for properties that have been owned for a while can catch up on all of the missed depreciation expenses identified in the cost segregation study from closed tax years without amending those tax returns. Furthermore, if the appraisal for a purchased property indicates that major structural components — roof, windows, boiler, etc. — will be replaced sooner than their 39-year depreciation lives, property owners need to ensure that those costs are itemized in a cost segregation study. When those components are replaced, the underappreciated balance can be written off.
Also, the costs of the landscaping and parking lots will be itemized as 15-year property in a cost segregation study. They generally do not burn, so why include them in a fire insurance policy?
The first step is to request a no-charge preliminary analysis. This usually can be done with one phone call and the results should arrive in a few days. When your accountant sees the tax benefits and the cost of the paid study and applies them to your specific tax situation, it will be obvious if it makes sense for you to commission the paid cost segregation study.
Those are your dollars that are hiding in your building. Find them with cost segregation.
With more than 20 years experience as a management consultant, Michael Donohue is the owner of CSStudies.com in Dobbs Ferry, New York.
Questions to Ask When Selecting a Cost Segregation Firm
• Do they pass all the tests defined by the IRS?
Read the Cost Segregation Audit Techniques Guide.
• Will they provide a free preliminary analysis specific to your property? It should estimate the tax benefits as well as quote the cost of the paid study.
• Will they insist on doing an on-site physical survey of your property?
• Do they have CPAs and tax attorneys to work with your tax preparers? When it comes time to apply the results of a cost segregation study to your tax return, you can be sure that your financial people will have questions.
• In the unlikely event of an IRS audit of the study, will your cost segregation firm attend that audit and defend their study at no additional charge to you?
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