If you have an interest in real property as an owner or tenant, a cost segregation study may be one of the tools to increase your cash flow or help manage your tax liability.
“These studies have saved both businesses and individuals hundreds of thousands of dollars,” says Walter McGrail, Principal at Cendrowski Corporate Advisors LLC.
Smart Business spoke with McGrail about these studies to better understand how companies might best utilize them.
What is the focus of the analysis?
A cost segregation study identifies and reclassifies personal property assets to shorten the depreciation time for taxation purposes, which reduces current income tax obligations.
The primary goal of a cost segregation study is to identify all construction-related costs that can be depreciated over a shorter tax life than the building.
Generally speaking, personal property assets identified in a cost segregation study might include items that are affixed to the building, but do not relate to its overall operation and maintenance.
What are the phases of the study?
The process will usually begin with a meeting between management and the firm conducting the study.
During the next phase, or the scope phase, the engineering professionals and tax accountants walk through all areas of the property with a site representative to develop a general overview.
Engineers also examine the architectural renderings or blueprints to produce an in-depth analysis. In addition, a review will be done on any construction contracts, capital expenditure budgets and reconciliations.
Next, the tax accountants take the engineers’ work and put it in format acceptable to the IRS. A report with documentation supports how the cost recovery was arrived at and takes into account any stipulations on allocations.
How is the amount of benefits determined?
First, the benefit is dependent upon the income tax savings generated from depreciation deductions claimed for income tax reporting purposes.
The costs incurred by a taxpayer in any capital expenditure program or property acquisition are recoverable as deductions in arriving at federal and state taxable income. Costs attributable to depreciable assets generate annual depreciation deductions reducing taxable income.
Second, the tax savings occurs for both federal and state income taxes. Depreciation deductions generally result in tax savings of approximately 40 percent of the deduction claimed.
Third, cost segregation studies identify categories of costs that have a shorter cost recovery period for income tax.
The actual savings is the reduction in current tax payments with resulting increases in taxes payable in subsequent periods, i.e., the ‘time value of money’ attributable to a sound treasury cash management program.
As with any treasury cash management program, a businesses’ cost of capital is the appropriate discount rate to measure the ‘present value savings’ of deferring cash charges for income taxes.
The higher an entity’s cost of capital, the more significant the present value savings attributable to deferring such tax payments.
What are the benefits of this study?
These studies have helped maximize tax savings and increase cash flows on current, future or past property purchases by maximizing tax deferrals.
Put another way, the benefit is the ‘present value savings’ attributable to the deferral of income taxes achieved via the acceleration of depreciation deductions resulting from shorter cost recovery periods identified during the study.
Generally, the depreciable tax life of most commercial buildings is 39 years. Recovery periods for personal property and land improvements range from five or seven and 15 years.
A cost segregation study identifies items that can be classified properly into categories with shorter tax recovery lives, which allows individuals and businesses to save hundreds of thousands of dollars through effective tax planning and improve cash flow. ●
Insights Accounting is brought to you by Cendrowski Corporate Advisors LLC.