Cost segregation studies can help
you maximize tax savings and
increase cash flows on your current, future or past property purchases
by maximizing tax deferrals.
“Almost anyone with an interest in real
property — whether an owner or a tenant — should consider having a cost segregation study conducted,” says Walter
M. McGrail, JD, CPA, senior manager at
Cendrowski Selecky PC. “Hundreds of
thousands of dollars may stand to be
achieved.”
Under IRS guidelines, the depreciable
tax life of most commercial buildings is
39 years. Accelerated methods can be
used to reduce the recovery periods for
personal property and land improvements to five or seven and 15 years. A
cost segregation study identifies items
that can be classified properly into categories with shorter lives.
Smart Business asked McGrail about
the benefits of having a cost segregation
study conducted.
What is the goal of a cost segregation
study?
A cost segregation study is an analysis
of the costs a taxpayer has in real property in order to break out the costs
attributable into shorter recovery periods for federal and state tax purposes.
The benefit is accelerated tax deductions by recovering the costs over five,
seven or 15 years, versus 39 years.
Depending on how personal and real
property is taxed in the locale where the
building is located, there can be significant property tax savings, as well.
Eligible properties include new buildings under construction, existing property that was purchased recently or
soon will be, and existing property that
was purchased after 1986 (the IRS
allows for catch-up for foregone savings). It doesn’t matter what the use of
the building is; industrial, retail, commercial/office, health care facilities or
even residential rental housing qualifies.
How much can be saved?
In general, it depends on three factors:
the cost to acquire the building, the money you are going to put into it and how
you are going to use the property. It is not
inaccurate to say that you could save several hundreds of thousands of dollars.
For example, if you spent $10 million on
a building, you might save $250,000 to
$1 million on a present value basis. We
usually see a greater percentage of savings with retail, office and hotel space.
What happens during the process?
There are several phases to the cost
segregation study. During the bid phase,
the engineering professionals and tax
accountants walk through all areas of the
property with a site representative to
develop a general overview. If granted
the engagement, the firm’s engineers
examine the architectural renderings or
blueprints to produce an in-depth analysis. 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. During the process,
the firm should examine the purchase
agreement to see if it contains any stipulations on allocations. Many times, during the 11th hour of negotiations, the parties will invite their tax professionals in,
and the accountants end up allocating
part of the purchase price. Quite often
we find something. For example, say the
building sold for $10 million, but a stipulation specified that $1 million had to be
allocated to good will. So you have to be
careful — stipulations need to be identified and honored.
Are there situations where a cost segregation study would not make sense?
It takes about five to seven years to
start recouping the tax savings, so you
may not realize the payback period if you
plan to sell the property in short order.
There may also be challenges down the
road if you try to use the building for a
tax-free swap, and you’ve already identified personal property through the cost
segregation study. In any case, a professional can review the options with you.
Every situation is different.
Any final words of advice?
Look at the level of expertise offered by
the firm that will do the study. A cost segregation study is not done in a vacuum —
it represents the marriage of an engineer’s viewpoint with the costs involved
with a property. The work needs to be
integrated, and the team of engineers and
tax professionals must be highly experienced and work well together. You might
also want to consider what types of
incentives the firm has. Larger or more
experienced firms might offer contingencies. For example, they might produce
the study for a fixed fee plus a percentage
of the tax savings recovered for you.
WALTER M. McGRAIL, JD, CPA, is senior manager at Cendrowski Selecky PC, Bloomfield Hills, Mich. Reach him at (248) 540-5760
or [email protected] or visit the company’s Web site at www.cendsel.com.
