Cost segregation studies can result in
significant tax savings for a property
owner, says David Hopkins, a Certified Public Accountant at SS&G
Financial Services, Inc. in Akron. Since
property can be divided into its component
parts, cost segregation studies are about
taking advantage of IRS rules to classify
assets and to then properly compute
depreciation for each asset.
Smart Business spoke with Hopkins
about the rules of cost segregation studies.
What is a cost segregation study?
A cost segregation study generally reallocates the costs associated with construction projects from real property to tangible
personal property. This reallocation often
allows for a tax savings because personal
property has a shorter lifespan and thus
can be depreciated over a shorter time
period and is eligible for accelerated depreciation, compared to real property that’s
generally depreciated over 39 years. Such a
study may be a useful tax-savings tool for
the owner of a building or for a tenant who
has made leasehold improvements to a
property. Since cost segregation studies
are complicated and carefully scrutinized
by the IRS, it’s very important that they’re
performed by experienced professionals
who can understand blueprints and construction specifications. There are CPAs
that specialize in conducting these studies.
What in a building could be reclassified as
The list is long and varied. For the purpose of a cost segregation study, things
such as landscaping, parking lots or sidewalks, carpeting and wallpaper could all be
reclassified as personal property. There are
also specific items for different building
types, such as lead walls in a dentist’s
office or power lines dedicated to machinery and equipment in a factory.
What are the financial benefits?
Cost segregation studies are conducted
with the goal of increasing cash flow via tax savings. If you own a $4 million building that’s being depreciated over 39 years,
you would have an annual depreciation
deduction of about $100,000. So, over
seven years, you’d see a depreciation
deduction of about $700,000. Implementing a cost segregation study that now
yields $1,575,000 worth of depreciation
deductions over a seven-year period gives
you $875,000 of additional deductions.
Assuming a combined effective tax rate of
40 percent, this represents a tax savings of
$350,000 over the first seven years.
Who should consider having a cost segregation study performed?
Generally, cost segregations can be performed on property that was acquired or
built after 1987. It should be considered by
an owner or owners of a building when
there has been a change in ownership or if
there have been major improvements or an
addition made to the property. New construction projects are ideal candidates for
cost segregation studies because actual
cost data and blueprints tend to be readily
What are the steps involved and how long
does it take?
A CPA will need to determine the purpose and function of all property. An analysis of all construction and engineering
drawings and specifications will be completed, and an on-site inspection of the
property will be done. A report will be provided to the owner upon completion that
explains the allocation of assets between
real and personal property and the class
life of the personal property, and it will also
include a summary of the tax savings and
additional depreciation deductions to be
claimed on the tax return. It takes about
two to six weeks to complete a study,
depending on the complexity of structure.
If I have a cost segregation study completed,
will I have to amend my prior tax returns?
No, this is certainly one of the benefits.
The IRS allows you to take the cumulative
adjustment on your next return. The mechanism would be a change in accounting
method filed with the IRS. This change is
automatic and requires no user fee. This
permits the taxpayer to use cumulative
catch-up depreciation in the current year
for a building that has been in service for a
few years. For instance, in the previous
example, if the building had been in service
for seven years, the catch-up depreciation
for the owner would be equal to $875,000.
Is a cost segregation study advantageous to
Cost segregations are complex and there
are many situations where it’s clearly not
advantageous. You have to evaluate your
particular situation. For instance, if you’re
contemplating selling the building soon,
you’d be out professional fees and would-n’t have the chance to reap the tax savings.
Also, if you’ve taken a lot of losses with no
ability to take additional losses, it isn’t
worth pursing a cost segregation study.
Many passive investors in real estate will
also fail to see a benefit if the cost segregation generates an overall tax loss for the
DAVID HOPKINS is a Certified Public Accountant at SS&G
Financial Services, Inc. Reach him at (330) 668-9696.