Tax Reporting for Cashflow Acceleration — FAQs
As we all know, IRS rules and regulations are extremely complex. Cost segregation involves not only specialized tax law knowledge, but construction engineering expertise such as the ability to read blueprints and building specifications. Even if your accountant understands the basics of cost segregation, without contractor/engineer expertise and a deep understanding of the relevant tax law changes, IRS Private Letter Rulings and court cases, valuable tax benefits will certainly be missed. IRS cost segregation audit guidelines clearly state that "a study by a construction engineer is more reliable than one conducted by someone with no engineering or construction background."
If your accountant is currently using the straight-line method of depreciation, it is highly likely that anywhere from 25% to 50% of building components can be reclassified to shorter depreciable lives, resulting in significant tax savings. On buildings where the owner has made substantial renovations, 90% of the costs could potentially qualify for accelerated depreciation, even where the building has been fully depreciated.
In the early days of cost segregation this might have been true, especially for owners of smaller commercial buildings. However, experience and methodology have brought costs within reach of the vast majority of commercial property owners . Further, the time and effort involved on the part of building owners or managers is minimal. And the savings can be substantial for any owner who pays federal income taxes. Savings generally range from 35% to 46% of the additional depreciation generated from the study.
Many owners and their accountants think that once they have established an accounting method they are locked into that way of depreciating their building. This myth keeps many owners from realizing one of the key advantages of cost segregation. For the perspective of the IRS, an owner who applies cost segregation is changing from an incorrect method, straight line, to a correct method, component depreciation. Not only is this change in method permitted, approval is automatic once a qualified cost segregation study has been performed and the building owner has completed and submitted an IRS form 3115. What’s more, IRS rules allow you to realize all of the depreciation adjustment for prior years in the year the study is completed, which can mean an immediate and significant increase in cash flow.
More than 75 IRS rulings, procedures and court cases have upheld the validity of cost segregation studies. Also, the IRS has published detailed audit guidelines and field directives for performing and documenting studies. Oxford Commercial Property Consultants has completed thousands of studies without a single successful challenge from the IRS.
Not necessarily. In many cases a 1031 exchange can be a viable option for owners planning to sell in the short term who still want to take advantage of cost segregation. Even if you do recapture the depreciation when you sell, you are gaining the use of that money now. In essence, performing a cost segregation study entitles you to a long term interest-free loan from the federal government. In most cases, the net present value of the tax savings provides a substantial return over the relatively modest cost of a study.
Also, in most cases the personal property components will depreciate in actual value, so their value at the time of sale will be close to their depreciation cost basis. Thus more of the sale gain will be allocated to real estate rather than personal property and taxed at the lower capital gains rate.
Using a cost-effective approach, and depending on the type of property, a cost segregation study can be a worthwhile investment for properties with values as low as $300,000.
Section 2.01 of the Appendix of Revenue Procedure 2002-9 allows an automatic change of accounting method without amending past returns. Your accountant will need to complete a form 3115 showing the calculation of the depreciation adjustment following the study.
Actually it matters a great deal. Because there is no "bright line" test for determining what items can be included in a cost segregation study, study levels can vary widely with corresponding variations in both cost and tax savings. A cost segregation study done at 10,000 feet by a CPA with no engineering or construction cost-estimating background might identify a few items, such as carpet or a parking lot, that qualify for accelerated depreciation. It is extremely unlikely, however, that this approach will identify more than a small fraction of what an owner is entitled to. More importantly, this methodology will not withstand IRS scrutiny.
As an example, an engineered cost segregation study on a $1,000,000 building should result in $250,000 to $500,000 of the components being accelerated, providing actual tax savings that could range anywhere from $87,500 to $230,000. Identifying all of the building items that can legitimately be accelerated requires specialized construction and engineering expertise combined with in-depth knowledge of the tax laws, IRS rules and court cases governing cost segregation studies. This is a key reason to choose a highly experienced team such as the one available with Cost Segregation Services, Inc.
Basic economics tells us that a deduction today is worth more than a deduction in the future. The tax savings generated by a cost segregation study is opportunity capital that is available to invest today. In essence, you are getting a long-term no-interest loan from the federal government to do with as you see fit. By contrast, not engaging a study means giving up all of the gain that could be realized from these investments. Also, depending on the age of the owner, a 39-year timeframe for all the depreciation may not be realistic.
Applying a cost segregation study may be one of the most lucrative strategies available in estate planning today. By employing step up in basis rules, both the current owner AND the future estate can take advantage of accelerated depreciation. Since the core purpose of estate planning is to maximize the future value and use of an estate, estate planning professionals who do not consider cost segregation are doing their clients a disservice.
IRS guidelines for Cost Segregation studies recommend an engineered approach coupled with the real estate accounting expertise needed regarding federal taxes and depreciation lives.
Most CPAs are understandably either too busy or not fluent in the detailed specifics of cost segregation and its application to tax accounting. Only the best accounting firms offer the services of the required combination of CPAs, appraisers, and construction cost engineers.
We do not want to take the place of an owner’s CPA firm, but rather we welcome the opportunity to work with them to ensure all of the assets are depreciated properly.
Absolutely not.
IRS guidelines suggest expertise in constructions methods and pricing. While most engineers are highly educated in the design of structures and equipment — blueprint analysis, cost estimating, and appraisal/valuation expertise are a rare combination.
There is virtually no true engineering involved in a cost seg study, it is a matter of being experts in how properties are constructed, how that relates to tax law, and how to quantify and price each asset.
A construction engineer with experience and training in a large tax accounting firm under CPAs and tax experts is the best choice. A valuation/appraisal background is required to properly do purchase price allocations.
Properly done cost segregation studies require a highly experienced team of individuals including CPAs, appraisers and construction cost estimators.
The cost of each cost segregation, purchase price allocation, and catch-up depreciation analysis varies based on the time involved, the number of locations analyzed, and the type of facility.
Please Call or Email us anytime to get a FREE estimate of the tax benefit and fees to complete the analysis. See our "Contact Us" page for our number and email address.
Yes. Here is a quote directly from the IRS’s Cost Segregation Guide:
"In order to compute depreciation using proper class lives and recovery periods, assets must be assigned to the proper asset classes. Cost segregation studies generally produce listings or groups of assets, based on asset classes under ACRS (Accelerated Cost Recovery System) or MACRS (Modified Accelerated Cost Recovery System). "
"In order to calculate depreciation for Federal income tax purposes, taxpayers must use the correct method and proper recovery period for each asset or property owned. Property, whether acquired or constructed, often consists of numerous asset types with different recovery periods. Thus, property must be separated into individual components or asset groups having the same recovery periods and placed-in-service dates in order to properly compute depreciation."
Not necessarily and be very wary of those who say it does. The rules of real vs. personal property and taxable vs. exempt vary from state to state.
While performing a Cost Segregation analysis we check the local property tax assessments and ensure the property is placed on the assessors’ tax rolls properly and fairly. If not, we can appeal the assessments to ensure the property is taxed fairly and accurately.
Yes. A Cost Segregation Study typically generates an additional depreciation of 35% to 47%. Our clients have recovered from $35,000 - $2.8 million.
Usually, 10% and 20% of the estimated present value of your tax savings. How large the project is, how many buildings, where in the U.S. it is located, and the quality of your records and documents also affect the total cost.
About 4 to 6 weeks from the time we receive all of your documentation.
Yes, but wouldn’t you rather have your money NOW? A Cost Segregation Study in effect gives you an interest free loan from the government for the first 15 years, which you will then repay interest free over the remaining 25 years.
Yes. As our clients have found, the present or future value of the money you can save by having a Cost Segregation Study done is usually quite substantial. Consider it an interest-free loan from the government.
They may not know. Until just recently, only the "Big Four" accounting firms did these studies on real estate of $125M and up. Also, a true cost segregation study involves an assortment of skilled individuals to get it done correctly. Many accounting firms just don’t have the skillsets required to complete a cost segregation study.
A complete set of construction plans, current tax depreciation records, building cost budget information, final AIA application and a document of certification for payment or other cost information, change orders, direct or indirect costs paid by the owner that are not included in other documents, and any other information about the project.
YES. We will send our construction, engineering and other specialists to your site to measure and estimate using currently accepted costing techniques and pricing guides. They will determine the costs that qualify.
NO. If they haven’t already trained and specialized in Cost Segregation Studies and how to document and substantiate their work, you can’t expect them to produce results that is likely to withstand IRS scrutiny and to assist with any IRS challenges.
YES. In fact, our documentation has withstood an IRS audit. The IRS agent engineer even commended our company for the "impressive level of detail provided." We thoroughly document each Cost Segregation Study to clearly support our conclusions so that they are easily communicated and resolved with the IRS.
