Technique allows buyers, owners to accelerate deductions

NORTH BAY – When a business is looking at purchasing a building for commercial use, one way to maximize deductions on a tax bill is to use cost segregation.

Cost segregation is a tool that breaks out a building or facility between structural and non-structural property and depreciates them at different rates.

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“What cost segregation allows,” said Jeff Carniglia, tax manager in the real estate industry group of Burr Pilger Mayer in Santa Rosa, “is the owner is able to pull out pieces of that building that would qualify as a shorter life, either a five-year life or seven-year life, and accelerate the depreciation.”

So for a $1 million dollar building, the regular deduction might be in the ballpark of $25,000 a year. But with cost segregation, likely the business can parcel out certain parts and get a much higher deduction.

“If you can get a cost segregation study done you are probably looking at getting potentially 60 percent of the cost up front through deductions,” he said.

In an article written by Shannon Affholter, a senior manager with Moss Adams highlighting the benefits of cost segregation, Rob Grannum, cost segregation services group chair at the firm, said, “In this economic climate, many business owners and real estate investors are utilizing tax savings strategies to help generate and preserve cash. Accelerating depreciation through cost segregation studies is one of the most common and effective strategies for cutting taxes and boosting cash reserves.”

In recent years, according to the IRS, increasing numbers of taxpayers have submitted either original tax returns or claims for refunds with depreciation deductions based on cost segregation studies.

According to the IRS, the underlying incentive for preparing these studies for federal income tax purposes is the significant tax benefit derived from utilizing shorter recovery periods and accelerated depreciation methods for computing depreciation deductions. The issues for service examiners are the rationale used to segregate property into its various components and the methods used to allocate the total project costs among these components.

Furniture and fixtures typically are depreciated over five or seven years. Land improvements, such as landscaping and parking lots, are depreciated over 15 years.

Cost segregation studies can be performed on purchased buildings, newly constructed buildings and tenant improvements. In addition, studies can be performed for buildings placed in service as far back as the mid-1980s, and no amended returns are required to claim the additional depreciation, experts said.

In 1999, the IRS said it would allow companies that have claimed less than the allowable depreciation in prior years to claim the omitted depreciation as a change in accounting method.

In 2002, the IRS announced that all of the prior years’ depreciation allowable under a cost segregation approach might be claimed in the change year.

Having an analyst perform a cost segregation can cost between $2,000 and $10,000.

“More often than not, though, they pay for themselves,” said Mr. Carniglia. “A lot of companies are being privy to this.”

And if you are going to buy a building under construction, he said it is advantageous to think about this when the contractors are doing paperwork and writing up invoices.

“You can tell how much is roofing, how much is electrical, how much is sprinklers. This way you are going to know upfront what your return on the asset will be.”

He said this should be done anytime a building is purchased.

While it was not as popular in recent years, he said he expects to see the technique come back as businesses start to see the benefit of purchasing their own buildings.

Appraisers of cost segregation studies are certified by the state.