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Are You Overlooking a 6 Figure Tax Break?
Save on Taxes with Real Estate Cost Segregation
Guest Post of the Month
July 2003
Are You Overlooking a 6 Figure Tax Break?
Save on Taxes with Real Estate Cost Segregation
Dave Massoth
dmm@tdip.com
If you own a building with a value greater than $1,000,000 or you own a number of facilities that collectively exceed this threshold, this article is important to you.
After careful research and examination, we have determined that significant tax savings can be achieved by accelerating income tax depreciation deductions permissible only recently by the IRS Procedures 2002-18 and 2002-19.
Valuable Tax Savings Imbedded in Buildings
The IRS permits the acceleration of depreciation of some assets that traditionally would be imbedded into the cost of buildings. In essence, they are allowing us to carve out shorter-lived assets (qualifying for 5,7, and 15 year write-off periods) that are normally imbedded in a buildingâs construction or acquisition costs (generally depreciated over 39 years). To meet IRS acceptance rules, an engineering-based cost segregation study must be conducted and used to justify the accelerated depreciation.
A cost segregation study involves identifying and properly reclassifying the capital amounts allocated to tangible personal property, other tangible property (i.e., IRC Section 1245 property), and land improvements from building costs.
You can "mine out" these buried savings from:
Profit from the benefit of cash flow savings! For every million dollars of property you reclassify for faster depreciation write-offs, the present value of your increased cash flow from income tax savings approximates $230,000.
What Types of Assets Have Shorter Write-Off Periods?
Generally speaking, assets that are an accessory to a companyâs business process are not considered part of the building itself and can be carved out for shorter tax write-off periods. Look at how a building is actually put together based on the companyâs industry to get a sense of which assets of a building are really related to the companyâs business process.
For example, the following assets can normally be carved out:
In a cost segregation study, look at each component of property and ask, What separates this from being part of the building or a structural component? The assets function or ultimate use helps determine if it is needed to provide services required by the companyâs business process.
Enjoy the Windfall For Real Property Built or Acquired Previously
You now have a valuable opportunity, courtesy of the IRS, if you constructed or purchased real estate in a prior year but did not take advantage of a cost segregation study. This IRS gift horse allows you to prospectively deduct (over one year period) depreciation amounts that you were legally entitled to but did not claim (e.g., due to erroneous property classification as a 39-year depreciable building).
This cash flow windfall is available to you even though the statute of limitations previously closed on the property construction or acquisition year.
Example:
Light Manufacturer acquired a facility four years ago for $6 million. Based on the cost segregation analysis, engineers determined that 30% of the building qualifies for short-life classification. By performing the cost segregation study, and filing required accounting method change documents, the manufacturer creates present value cash flow savings from tax reduction approximating $310,000!
A Solid Case for An Engineering-Based Approach
Cost segregation is not new per se. In fact, CPA firms have been doing them for years. The difference is that the IRS has changed the rules. They will no longer accept the accounting-based cost segregation methods commonly used by traditional CPA firms.
The IRS wants engineering-based cost segregation studies that have indisputable evidence for the tax savings. A cost segregation analysis should be based upon all construction documents and physical examinations not just invoices. A complete âaudit trailâ traces derived unit costs from contract documents and other source data.
Can My General Contractor Do the Study?
Cost segregation is a highly specialized segment of tax law. The volume of judicial decisions, IRS rulings, regulations, and other interpretations span thousands of pages of text. The challenge is to apply this complex knowledge to the unique facts of your industry, your companyâs circumstances, and the processes of your operation. That is why we recommend the use of Cost Segregation specialists who have conducted thousands of cost segregation studies throughout the United States.
Why take unnecessary risks? A General Contractor doesnât understand tax laws and is not likely to have the expertise to do this properly. In addition, this is not their main line of work and may only offer a sub par service as a sales tool. This means that they will likely leave valuable tax benefits "on the table". Moreover, the foregoing will likely not withstand IRS examination.
dmm@tdip.com
If you own a building with a value greater than $1,000,000 or you own a number of facilities that collectively exceed this threshold, this article is important to you.
After careful research and examination, we have determined that significant tax savings can be achieved by accelerating income tax depreciation deductions permissible only recently by the IRS Procedures 2002-18 and 2002-19.
Valuable Tax Savings Imbedded in Buildings
The IRS permits the acceleration of depreciation of some assets that traditionally would be imbedded into the cost of buildings. In essence, they are allowing us to carve out shorter-lived assets (qualifying for 5,7, and 15 year write-off periods) that are normally imbedded in a buildingâs construction or acquisition costs (generally depreciated over 39 years). To meet IRS acceptance rules, an engineering-based cost segregation study must be conducted and used to justify the accelerated depreciation.
A cost segregation study involves identifying and properly reclassifying the capital amounts allocated to tangible personal property, other tangible property (i.e., IRC Section 1245 property), and land improvements from building costs.
You can "mine out" these buried savings from:
- New buildings presently under construction.
- Existing buildings undergoing renovation, remodeling, restoration, or expansion.
- Prior Purchases of existing property.
- Office/facility leasehold improvements and "fit outs".
- Post-1986 real estate construction, building acquisitions, or improvements where no cost segregation study was performed (even though the statute of limitations previously closed on the property construction/acquisition year).
Profit from the benefit of cash flow savings! For every million dollars of property you reclassify for faster depreciation write-offs, the present value of your increased cash flow from income tax savings approximates $230,000.
What Types of Assets Have Shorter Write-Off Periods?
Generally speaking, assets that are an accessory to a companyâs business process are not considered part of the building itself and can be carved out for shorter tax write-off periods. Look at how a building is actually put together based on the companyâs industry to get a sense of which assets of a building are really related to the companyâs business process.
For example, the following assets can normally be carved out:
- Security systems
- Phone and intercom systems
- Emergency back-up generators
- Site improvements
- Carpeting
- Kitchen equipment
- Computer room access flooring
- Computer cabling and receptacles
- Identity signage
- Removable wall coverings
- Vinyl composite tile
- Dry sprinkler systems
- Special plumbing, electrical and HVAC
- Woodwork such as built-in cabinetry
- And many others.
In a cost segregation study, look at each component of property and ask, What separates this from being part of the building or a structural component? The assets function or ultimate use helps determine if it is needed to provide services required by the companyâs business process.
Enjoy the Windfall For Real Property Built or Acquired Previously
You now have a valuable opportunity, courtesy of the IRS, if you constructed or purchased real estate in a prior year but did not take advantage of a cost segregation study. This IRS gift horse allows you to prospectively deduct (over one year period) depreciation amounts that you were legally entitled to but did not claim (e.g., due to erroneous property classification as a 39-year depreciable building).
This cash flow windfall is available to you even though the statute of limitations previously closed on the property construction or acquisition year.
Example:
Light Manufacturer acquired a facility four years ago for $6 million. Based on the cost segregation analysis, engineers determined that 30% of the building qualifies for short-life classification. By performing the cost segregation study, and filing required accounting method change documents, the manufacturer creates present value cash flow savings from tax reduction approximating $310,000!
A Solid Case for An Engineering-Based Approach
Cost segregation is not new per se. In fact, CPA firms have been doing them for years. The difference is that the IRS has changed the rules. They will no longer accept the accounting-based cost segregation methods commonly used by traditional CPA firms.
The IRS wants engineering-based cost segregation studies that have indisputable evidence for the tax savings. A cost segregation analysis should be based upon all construction documents and physical examinations not just invoices. A complete âaudit trailâ traces derived unit costs from contract documents and other source data.
Can My General Contractor Do the Study?
Cost segregation is a highly specialized segment of tax law. The volume of judicial decisions, IRS rulings, regulations, and other interpretations span thousands of pages of text. The challenge is to apply this complex knowledge to the unique facts of your industry, your companyâs circumstances, and the processes of your operation. That is why we recommend the use of Cost Segregation specialists who have conducted thousands of cost segregation studies throughout the United States.
Why take unnecessary risks? A General Contractor doesnât understand tax laws and is not likely to have the expertise to do this properly. In addition, this is not their main line of work and may only offer a sub par service as a sales tool. This means that they will likely leave valuable tax benefits "on the table". Moreover, the foregoing will likely not withstand IRS examination.
These articles are intended to provide general resources for the tax and accounting needs of small businesses and individuals. Service2Client LLC is the author, but is not engaged in rendering specific legal, accounting, financial or professional advice. Service2Client LLC makes no representation that the recommendations of Service2Client LLC will achieve any result. The NSAD has not reviewed any of the Service2Client LLC content. Readers are encouraged to contact their CPA regarding the topics in these articles.
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