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Cost-Segregation Savvy

October 13, 2011 Leave a comment Go to comments

Know the basics before pursuing a tax study.

by Donald A. Greenhalgh, CPA

If you’ve been using cost-segregation studies to accelerate depreciation of your commercial property, you’ve likely cut your taxes considerably. But could you save even more?

Not all cost-segregation studies are created equal. So what can you do to maximize the savings from cost segregation?

First, you will need to understand what a cost-segregation study is and how it can reduce your taxes. If no cost-segregation study is conducted, the commercial building you own will be depreciated over 39 years, using the straight-line depreciation method.

When a cost-segregation study is performed, a building instead is considered as a collection of pipes, doors, wood trim, electrical switches, countertops, and hundreds — or even thousands — of other components.

Land improvements, which include landscaping, sewers, paving, and curbing, can be depreciated over 15 years. Personal property, such as finish carpentry, emergency power generators, cabinets, and even certain heating, ventilation, and air conditioning units, can be depreciated in five or seven years.

By segregating these costs, typically 10 percent to 30 percent of the purchase price of a building can be reallocated for depreciation over shorter periods. If you spend $10 million on a building, for example, it’s likely that $1 million to $3 million can be reallocated. That works out to a tax savings of $50,000 to $70,000 per $1 million. And you can keep on saving every year for up to 15 years.

Maximizing Cost Savings

Because cost-segregation studies require combined expertise in construction, engineering, and accounting, it is important to work with qualified professionals. Engineering firms typically perform the study, but the Internal Revenue Service has strict guidelines for qualified cost-segregation studies. Make sure the engineering firm is working with accountants who fully understand the tax implications of the study.

Jeffrey Hiatt of MS Consultants, a cost-segregation firm, also suggests following these guidelines to get the most from your study.

Get a detailed report. Be certain that the study documents all costs in great detail, down to every light switch and every square inch of space. Many firms do not go into as much depth as they could and, as a result, do not save clients the maximum amount possible.

Ask for a cost and savings estimate. Before you sign a contract, the firm should give you an estimate of savings and costs. The cost of a study can vary depending on the size of the project, but the firm conducting the study should be able to estimate your potential savings before you incur any cost. Typically, every dollar spent on the study should net a tax deferral of at least $10, and sometimes the savings can be much higher.

Be wary of contingency contracts. Consider getting multiple bids, but only hire a firm that has significant experience. Do not hire a firm that offers to do the study on a contingency fee basis — unless you like the idea of being audited. The IRS frowns on arrangements that give a third party an incentive to reduce your taxes.

Break it down. The firm should provide a breakdown by tenant, floor, and unit. Any space also should be broken down by function, such as manufacturing area, clean-room area, and office space. Such breakdowns are especially valuable to owners that change tenants regularly, such as retail property owners, and those with specialized construction, such as owners of laboratory space. When the owner of retail space, for example, replaces a shoe store with a restaurant, significant changes will need to be made. The “abandonments” that are junked in a dumpster can be written off, but only if they are properly recorded.

Cost-segregation studies can save owners of commercial property a great deal of money, but they are not appropriate for every job. They should be considered whenever project costs exceed $750,000, but they should be undertaken only if they can create a reallocation of at least $5 for every $1 spent.

The more you know about cost-segregation studies, the more you are likely to save.

Donald A. Greenhalgh, CPA, is a partner in the Real Estate Practice Group at DiCicco, Gulman & Co., a business consulting firm located in Woburn, Mass. Contact him at  dgreenhalgh@dgccpa.com.

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