What is Cost Segregation

WHAT IS COST SEGREGATION

Cost Segregation is an application by which commercial property owners accelerate depreciation and reduce the amount of taxes owed. This savings generates substantial cash flow that owners often use to reinvest in their business, purchase additional property, or apply to their principal payment.

Cost Segregation is simple, legal, and recommended in the August 2004 Journal of Accountancy for CPAs. The article states, “A taxpayer can substantially increase cash flow by segregating property costs.”

HOW DOES COST SEGREGATION WORK?

A Cost Segregation Study accelerates the depreciation of a building or renovation components into shorter depreciation categories. Decorative items such as carpet, molding, and interior windows can be moved from 39- or 27.5-year depreciation to a 5- or 7-year category. The 15-year category would include landscaping, hardscaping, site utilities, and paving also known as land improvements.

This engineering-based cost segregation study results in much higher depreciation expense and significantly reduced taxable income for the property owner. Best of all, the ruling states cost segregation can be applied to categories of buildings purchased or built since 1986, including renovations, and there is no need to amend your tax return. The fee paid for a study is always a taxdeductible business expense.

Origins of Cost Segregation

1/ Hospital Corporation of America US Tax Court 109 T.C.21 – Aug. 24, 1997 Owed $800,000,000 Sought to apply cost segregation to reduce the amount owed Judge Tom Wells rules in favor of HCA Precedent is set for commercial property owners.

2/ Walgreen’s Drug Stores Used as a precedent by HCA Previously won the case in District Court to change the method of depreciation Changed to accelerated depreciation resulting in lower tax liability Change in tax view: personal vs. structural 5, 7, 15 years vs. 27.5 or 39 years depreciation

GUIDELINES “FOR A QUALITY STUDY

1. Preparation By an Individual with Expertise and Experience

2. Detailed Description of the Methodology

3. Use of Appropriate Documentation

4. Interviews Conducted with Appropriate Parties

5. Use of Appropriate Nomenclature

6. Use of a Standard Numbering System

7. Explanation of Legal Analysis

8. Determination of Unit Costs And Engineering “Take-Offs”

9. Organization of Assets Into Lists or Groups

10. Reconciliation of Total Allocated Costs to Total Actual Costs

11. Explanation of the Treatment of Indirect Costs

12. Identification And Listing Of Section 1245 Property

13. Consideration Of Related Aspects (e.g. IRC §263A. Change in Accounting Method And Sampling of Techniques)

NEW TPR BASED COST SEGREGATION STUDY

The process has evolved. The 2014 final repair and maintenance regulations are the biggest tax change since 1986. First, the existing depreciation schedule must be scrubbed and any items that do not rise to the new level of capitalization MUST be expensed. Second, moving forward there are new capitalization criteria and three safe harbors that can be utilized to expense expenditures that would normally be capitalized. CPAs and other tax professionals should have informed their clients of these safe harbors so they can strategize about which repairs should be made and when.

Cost Segregation breaks down each building system and structural component.

All future expenditures can be compared to the numbers on the report.

Personal property is segregated from real property (1245 vs 1250).

The tax savings is typically between $40k to $80k per $1M in building cost.

Works on $250k+ buildings.

Apartments, strip centers, rental properties, office building, self-storage, medical, hotels, etc.

We analyze each building and address any repair regulation discrepancies we see.

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