Why cost segregation could benefit you
When I introduce the subject of cost segregation for tax savings to commercial building owners, eyes wander and feet shuffle. They are bored before I start the next sentence.
So I'll take a different approach. What if I told you that you could recoup up to $100,000 for every $1 million of your building's value?
Hopefully I've got your attention.
Cost segregation refers to IRS rules that allow building owners to accelerate depreciation of 'personal' building assets.
Personal assets for a commercial building are basically anything that can't be removed from the building. Things like plumbing, lighting, electrical systems, machinery, and landscaping (even outdoor hardscape that is not part of the building) qualify.
Standard depreciation for commercial real property is 39 years. The IRS allows personal property,depending on the nature of the assets,to be depreciated over 5,7 and 15 years. Dividing property into separate asset classes allows owners to accelerate depreciation tax deductions, reducing their tax liability and increasing cash flow.
For most buildings, 25 percent-35 percent of a building's assets qualify as personal assets.
Let's do the math.
If you have a $10 million building and 30 percent of it, or $3 million, is classified as personal property,the net present value of the tax benefit is approximately $300,000.
Since the IRS allows you to depreciate personal property in as little as five years, as opposed to 39 years for 'real property,' the benefits of cost segregation are very real.
What the IRS requires to do this is known as a Cost Segregation Study, typically an engineering study based on blueprints that document what is real property and what is personal property.
A cost segregation study is a technical report created by engineers that comb through a building's blueprints to prepare a detail of the assets that qualify as personal property.
This report is the documentation you will need to support your tax claims. It's important to note that this is not a building inspection but an engineering study. The reason for this is that the IRS has stated to its agents that a 'detailed engineering approach' to cost segregation 'is the most methodical and accurate approach, relying on documentation and minimal estimation.'
In other words,the IRS will accept a cost segregation engineering study as proper documentation for asset classification.
If you haven't taken advantage of the accelerated depreciation of personal property assets in your building, it's not too late. The IRS allows for a one-time 'catch-up' depreciation filing that allows owners to recover missed depreciation savings. This has delivered welcome windfalls to the owners that have taken advantage of it.
Unfortunately, not many owners know about cost segregation, and many that do are afraid it is some kind of risky loophole that will draw IRS scrutiny.
A couple of decades ago this was the case, but the issues worked their way through the courts and, to make a long story short, building owners prevailed in 1997. The eligibility requirement for cost segregation are simple and few: The owner must be paying federal taxes, and the building must have been built or remodeled after 1987 (the year that the IRS introduced shorter depreciation schedules for personal property assets). Existing properties, new construction, leaseholds, renovation/remodeling, or abandoned properties slated for demolition are all eligible.
Practically speaking, a building should have a cost basis of at least $500,000 in order for a cost segregation study to be cost-effective.
It is also recommended by most cost segregation consultants that the owner keep the property for at least 12 months after performing the study to realize its benefits.
Is cost segregation right for you? The best way to find out is to contact a financial advisor, CPA, or engineering firm that specializes in cost segregation studies.