It never hurts to have someone on the inside, letting you in on the latest ways to save a dollar especially when it’s a tax dollar. According to Chris Hitselberger, senior managing director at CB Richard Ellis, an engineer with tax code experience could be your new best friend. He or she can conduct a cost segregation study to point out places within a building that can be subject to greater depreciation, and lower taxes.
“This is a technique of accelerating the depreciation on a commercial building or multi-family building that will create about $30,000 to $150,000 in tax benefits per million dollars of a building’s cost,” he says.
Smart Business spoke to Hitselberger about what an owner needs to know about cost segregation studies.
What is required of an owner for a cost segregation study?
Although executing a report is quite a detailed engineering endeavor, it doesn’t take much effort from the building owner. The studies are relatively non-intrusive. The building owner provides the tax basis typically the tax basis is the acquisition cost minus the land, since the building depreciates and the land does not or new construction costs in a new construction project. Providing complete and organized blueprints, or a greater level of cost detail than is normally tracked during a construction project, certainly helps.
Is the history of the building purchased relevant?
The age of the building is irrelevant. Every time a new owner takes over a space or a building, it starts a new tax clock. So the building may be 100 years old, but if you just bought it this year, you begin depreciating that building today for the next 39 years, or 27-and-a-half years in the case of a multi-family building.
What are some typical building components in which savings can be found?
Components that are in the nature of supporting the client’s business activity or can be removed without doing significant damage to the building may qualify to be treated as personal property for federal tax purposes. So we look at such things as the electrical system. In the average office, you need one electrical outlet, but there might be four electrical outlets in somebody’s office. One of those outlets writes off over 39 years or 27-and-a-half years along with everything that makes the outlet work: the conduit, the wiring, the circuit breaker, etc. that write off over 39 years. The nature of the intended use of the other outlets is just to plug in office equipment copiers, printers, fax machines, etc. so those outlets, because they support personal property, depreciate as personal property. So there might be a dataport that also plugs into the computer. The dataport and all the wiring write off over five years.
Interior walls or tenant improvements that do not penetrate the plane of the suspended ceilings can be five-year walls. Work cubes made out of permanent walls, drywall and studs, etc. are only 4-feet high, so those are five-year walls. As long as that wall can be considered demountable, meaning you can move that wall without disturbing the suspended ceiling system, it’s probably going to be a five-year wall.
Then everything from the edge of the property to the edge of the building can write off over 15 years. Those are site improvements, such as parking lots, landscaping, sidewalks, exterior lighting, or signage.
By moving these costs into five, seven and 15 years, it creates an accelerated depreciation, which increases the present value of the cash flow that’s created by depreciating the building.
Can a cost segregation study withstand scrutiny from the IRS?
Cost segregation is an IRS recognized technique. In fact, the IRS has created an audit technique guide, which anybody can access. It’s at www.irs.gov. Search for ‘cost segregation’ at this site, and it will take you to the audit technique guide. And it has a lot of interesting information about the history of cost segregation.
Who should take the lead on a cost segregation study?
It’s really the function of an engineer who understands this part of the tax code. Accountants simply aren’t taught how to read blueprints. They’re not taught how buildings are built, which is an essential skill. Accountants certainly play a key role in that they incorporate the results of the study for their clients. They take reported information and incorporate it into their depreciation schedules.
It’s not only the knowledge of engineering and construction procedures, it’s also the knowledge of the tax law. Because even though an engineer may have gone to a seminar that says a chandelier can write off over five years, it’s very important to understand why. You need to know what part of the tax code, or what legal precedent, there is behind your argument to write that chandelier off over five years.
CHRIS HITSELBERGER is senior managing director with CB Richard Ellis. Reach him at (212) 425-4300 or firstname.lastname@example.org.