Cost Segregation - The IRS approved method for accelerating building depreciation.
The Way It Works
Building costs are generally classified for federal income tax purposes into three categories. Each has a different depreciation recovery period and method under the Modified Accelerated Cost Recovery System ("MACRS"):
TANGIBLE PERSONAL PROPERTY 5 OR 7 YEARS 200% DECLINING BALANCE
LAND IMPROVEMENTS 15 YEARS 150% DECLINING BALANCE
REAL PROPERTY 39 YEARS STRAIGHT LINE
A cost segregation study will identify items that can be properly classified as tangible personal property or land improvements rather than real property that is depreciated over 39 years. The resulting tax benefits begin in the quarter the study is complete and continue throughout the depreciable life of the identified assets.
Does the property have and adjusted cost basis of $750,000 or higher? In some cases less.
Do you operate as a For-Profit Entity and pay Federal income taxes? Corporate and/or Personal?
Do you plan to hold the property for at least one more year? Short Term or Long Term?
CPA’s / Accountants and Cost Segregation
CPA’s and Accountants should not be expected to conduct Cost Segregation Studies because they lack the Cost Segregation Specialist skill set for conducting Cost Segregation Studies. A Cost Segregation Specialist must have construction engineering experience and understand how to conduct building takeoffs from site plans, blueprints, and/or simple measurements. Make determinations of asset classifications based upon building use. They must also keep up to date with all current and changing rules and regulations put in place by the IRS, including relevant court cases and revenue procedures. Some CPA firms have hired construction engineers or appraisers to provide this service to their clients; however, most firms do not have the resources or amount of work to justify the expense. Most CPA or large regional accounting firms hire outside third party Cost Segregation providers, who specialize in Cost Segregation, to provide this valuable service to their clients. If you own Commercial or Residential Rental Property and your CPA/Accountant has not discussed Cost Segregation with you, there is an excellent chance it has not been conducted on your property.
Engineering-Based Cost Segregation
The IRS states that the Engineering Approach to Cost Segregation is the most methodical and accurate methodology for performing a Cost Segregation study. By using the detailed engineering approach with actual cost records, or, the detailed engineering cost estimate approach with costing data from contractors, or from reliable published sources such as R. S. Means, or Marshall Valuation Service, will provide the client with the most reliable results. The IRS further requires that unit costs be applied to each and every project component to determine the overall project cost. Once the total project costs are determined from quantitative take-offs and/or cost records they must be reconciled with the total actual costs paid for the building.
Whether you have recently acquired or constructed a building or have owned your building for several years, you could benefit from an Engineering Based Cost Segregation Study. Current tax law allows you to claim "catch up" depreciation for prior years and realize the tax benefits in the current year without an amended return.
Most cost segregation companies will provide a Free, No Cost, No Obligation property evaluation that will lay out the expected benefits and the flat fee required to complete the study. Thus giving you the opportunity to review the potential benefits with your CPA or financial advisor and allowing you to make an educated decision whether or not to move forward with the study based upon your anticipated return on investment.
Not All Studies Are Created Equal
M&E Engineering Based Cost Segregation vs. The Residual Providers
As more and more property owners are learning about the benefits of cost segregation, the need to assess the quality of cost segregation providers is becoming essential. Property owners and CPA's need to understand the risks involved and the benefits that could be lost, if the right provider is not chosen.
The IRS recommended approach to Cost Segregation is the Engineering Approach. Most cost segregation companies claim to be using an Engineering Approach, however the majority of them are actually providing an abbreviated version known as a Residual Study. While they may use Engineering methods to identify and assign costs to the short life assets, they simply lump the remaining balance in to the long life "Real Property" category. Listing the long life assets in one to a dozen broad categories without providing asset detail. Often times, these studies will leave out many items that should be reclassified, resulting in lost benefits to the property owner. By not providing detail of the long life assets and reconciling all project costs, the study may even overestimate the amount personal property, leaving the owner open to increased scrutiny and risk in the event of an IRS audit. What's more is that these providers are typically charging between 75-100% of the TRUE Engineering Based Cost Segregation Study even though their short-cut approach takes less than half the amount of work.
M&E Cost Segregation Provides a Different Type of Study
We conduct our studies using the TRUE Engineering-Based Methodology. A TRUE Engineering-Based Study or Report will have as much detail for the remaining long life assets as it does for the short life assets. This means that every asset in the property is assigned both the depreciable life and a project cost. All short life AND long life assets are reconciled and accounted for. The property owner will receive the greatest tax benefit that the comfort of knowing that the study is fully supported. Each and every study we produce has all the necessary detail, documentation and supporting workpapers to stand on their own. However, in the event of an IRS audit and/or if any questions are raised, we will defend our studies at no additional cost. We will even cover any necessary travel costs. In addition to receiving the greatest tax benefit from a TRUE Engineering Based Cost Segregation Study, the property owner can also take advantage of the ability to write off long life assets in the years following the study. This is due to the fact that each long life asset has been assigned a depreciable cost and a project cost. If a long life asset such as a roof or air-conditioning unit needs replaced in the next 39 years, the owner can write off the remaining depreciable balance of the component all in the same year. This can amount to tens, or hundreds, of thousands of dollars in tax benefits that would otherwise be lost.
Don't Be Fooled By Imitators
After the IRS issued the Cost Segregation Audit Techniques Guide in 2004, many Residual Cost Segregation providers began claiming they conduct Engineering Based Cost Segregation Studies. Currently, several companies in our industry are now providing a Hybrid study; using Engineering methods to produce a “Residual” study. A Residual study simply assigns project costs of the short life assets and then lumps the remaining basis into the 39 year depreciable life classification. Before deciding on a provider, ask to see a sample their final report. It should show the same amount of detail for the long life assets as it does for the short life assets.
Ask to See a Sample Report
Before deciding on a provider, ask to see a sample their final report. Check the long life 39 or 27.5 year detail. How many line items do you see? A true Engineering Based Cost Segregation Study will provide hundreds or thousands of line items detailing the building's long life components.
Property owners owe it to themselves, and their wallets, to make sure that they are receiving a Complete and True Engineering-Based Study that will provide them the greatest benefit, both at the time of the study and for the life of the property.
Contact Us for Free, No Cost, Property Evaluation.