If your business has recently invested in construction or purchased commercial real estate, consider getting a cost segregation study. These studies offer immediate and significant tax savings through accelerated depreciation deductions for current tax provisions and improved cash flow.
“If you buy a building and it’s all capitalized as one lump sum on a business’s tax return, then it can only be depreciated over 27 to 39 years,” says Matthew Sanders, CPA, audit manager at Rea & Associates. “But if you break it down into cost components, the business owner can depreciate certain costs over five, seven or 15 years to accelerate tax deductions.”
Smart Business spoke with Sanders about the benefits of a cost segregation study.
Who should consider getting a cost segregation study? Are there instances where this can be more valuable?
Companies that are either constructing or purchasing a building can benefit from cost segregation studies. Also, cost segregation studies can prove valuable for renovations, depending on the total cost.
The type of facility plays a part in the cost benefit. The more complicated the building, the more worthwhile a study might be. If it’s just a warehouse that’s going to be used for storage, it may not have a significant amount of separate components that would assist you in accelerating depreciation like electric, plumbing, HVAC systems, offices, etc.
What are the benefits to a study?
It’s a time value of money benefit. By accelerating your tax deductions and reducing your tax liability, you increase your current cash flow. This can prove important to a business when making such a large investment. Studies have shown that the amount of costs that can be reclassified to a shorter recovery period range from 15 to 40 percent of total costs. It still ends up in your favor if the study costs $10,000 to $20,000.
Besides immediate tax savings and increased cash flow, a cost segregation study assists in creating great records and an audit trail that could help to resolve IRS inquiries quickly. A business isn’t more likely to be audited because of a cost segregation study, but in the event it does get audited, it’s helpful to have these records on hand.
There are also potential opportunities to reduce real estate tax liabilities and identify sales and use tax savings opportunities.
When should you get a study done?
It’s best to perform a cost segregation study within a year of purchase or construction. But if you have a look-back study done a few years after you are in the building, the IRS allows you to catch-up. You’ll have a lower tax liability that first year because you’re catching up the depreciation.
The longer you wait, however, the more you’ve already recognized the depreciation on the building so the catch-up may not be as great and the cost benefit can be lower.
How can new rules help with writing off replacement costs?
Cost segregation studies assist in identifying the replacement cost of a specific component of a building, which can be written off in the year of replacement under new IRS regulations.
For example, if a building owner replaces a roof on the building and no study was performed, the costs of the replacement are capitalized on the building owner’s depreciation schedule. Essentially, he or she could be depreciating both roofs. Under the current IRS rules, the value of the old roof (if known) can be written off in the year the replacement is performed.
What are the first steps to getting started on a cost segregation study?
If you think a cost segregation study might make sense for your organization, call your CPA or business adviser. They can help you do an assessment of how valuable a cost segregation study could be and help you gather the necessary records.
Studies can take one to two months, so plan on setting aside some time to work with the engineering specialist.
And while good records are important, an experienced engineer should be able to do an extensive site visit if you don’t have the necessary records available. This includes measuring and estimating costs using accepted techniques and pricing guides to identify all property costs and determine which components qualify for shorter recovery life periods.
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