07 Oct Getting the Most from Cost-Segregation Studies
Getting the Most from Cost-Segregation Studies
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 equally. 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 takes place, 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 HVAC units, can be depreciated in five or seven years.
By segregating these costs, typically 10% to 30% 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.
Tips for 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 IRS has strict guidelines for qualified cost-segregation studies, so be certain that the engineering firm is working with accountants who fully understand the tax implications of the study.
Jeffrey Hiatt of MS Consultants, LLC also suggests:
- 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.
- Get an estimate of savings and of costs before you sign a contract. 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. Â Typically, every dollar spent on the study should net a tax deferral of at least $10 and sometimes the savings can be much higher.
- Consider getting multiple bids, but only hire a firm that has significant experience. Also be certain not to 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 would give a third party an incentive to reduce your taxes. Because of this, firms with significant expertise should know better than to offer to work for a contingency fee, so be suspicious of firms that make such an offer.
- Be certain that whoever is retained for the study provides a breakdown by tenant, floor and unit. Any space should also 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 owners of retail space, and to owners of property with specialized construction, such as owners of lab 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.
About the Author
Donald A. Greenghalgh, CPA, is a Partner in the Real Estate Practice Group at DiCicco, Gulman & Co., a CPA and business consulting firm located in Woburn, MA. He can be reached at dgreenhalgh@dgccpa.com
© 2011 CCIM INSTITUTE. Reprinted with permission from Commercial Investment Real Estate magazine, Vol. XXX No. 5.