If your company is planning to build, purchase or renovate a building, or has done so in the past several years, a cost segregation study could help boost your cash flow and save your company significant money, says Chris Bzinak, CPA, senior tax professional at Clark Schaefer Hackett.
Cost segregation studies separate personal property from structural components, putting personal property into depreciable categories, which allows taxpayers to depreciate property over much shorter periods of time as opposed to the standard 39-year (or 27.5-year residential) time frame. By taking these deductions sooner, property owners lower their current-year tax liability and free up more capital.
Smart Business spoke with Bzinak and Kathy Pugh, CPA, tax director, about how cost segregation studies can be a smart tax strategy.
How should property owners determine whether a cost segregation study will benefit them?
First, property owners should understand their tax situation up front. Is it advantageous to accelerate deductions now, rather than in the future?
The experts performing the study can discuss on a case-by-case basis whether the money owners invest will be worthwhile. Typically, a facility should have been placed in service within the last five years, and the cost of the building, remodel, expansion or build-out needs to be at least several hundred thousand dollars. Generally, a free feasibility study will show the amount of increased deductions and cash flow over the life of the building, which gives property owners the ROI and the net present value of their tax deferral.
What type of savings can property owners expect?
In general, 20 to 40 percent of the purchase can be reclassified as personal property and depreciated more quickly, usually in five-, seven- or 15-year increments. Flooring, signage, landscaping and parking lots are examples of components that can often be reclassified.
Tax law changes to expensing rules, however, have increased the benefit of cost segregation. Now, anything that falls under a 20-year depreciable life is eligible for bonus depreciation, which means property owners can take 100 percent of the cost in year one. Roofs, HVAC systems, fire alarm systems and security systems installed on existing commercial buildings also may be eligible for immediate expensing under Section 179.
Are there any risks to doing a cost segregation study?
Property owners should ensure those doing the cost segregation study are utilizing an IRS-approved method with documentation that can stand up to an audit. Rather than doing a full cost segregation study with a reputable firm, some property owners will come up with estimates without the proper analysis and site visit. If they use those generalities to adjust their tax return, they face the risk of an IRS audit without evidence to support their actions.
How should building owners prepare for the analysis? How will the study be conducted?
Once an owner decides to go forward with a study, the experts conducting the study will need to ask questions, look through the appropriate documents and do a site visit to take photos, measure and count different items in the facility. If a building is newly constructed or remodeled, it’s important to have the contractor’s payment applications and facility blueprints ready. An older building’s study can be based on a depreciation schedule and appraisal from the time of purchase.
A report that breaks down the reclassification will then be issued to the property owners, who can take that to their accountants and apply it to their taxes. Most likely, this will not require them to amend their tax return; the owners just file a Form 3115, which is an application for change in accounting method to adjust their deprecation.
Under today’s tax rules, virtually every taxpayer who owns, constructs, renovates or acquires a commercial (or residential) real estate facility stands to benefit from a cost segregation study. Is it time to see if you can recover your capital investment sooner?
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