Know the basics before pursuing a tax study.
If you’ve been using
cost-segregation studies to accelerate depreciation of your commercial
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
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
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
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.
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
Ask for a cost and savings
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
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
Break it down.
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.
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 email@example.com.