By partaking in a cost segregation study, your company can recognize significant tax savings in real, permanent dollars. Although the overall concepts have existed for some time, certain court cases and rule simplifications have made cost segregation increasingly popular. Also, the green movement in construction and recent tax law changes like the Economic Stimulus Act have added additional considerations.
“A large percentage of the companies we meet with move forward with cost segregation,” says Peter A. Bellini, CPA, a principal at Skoda Minotti, a Cleveland-based firm of CPAs and business and financial advisers.
Smart Business spoke to Bellini about how cost segregation identifies, segregates and reclassifies the physical assets of your business that qualify for shorter, depreciable tax lives.
What is cost segregation?
Cost segregation is an IRS-approved method of reclassifying components and improvements of a commercial building from real estate to personal property. The process allows the assets to be depreciated on a five-, seven- or 15-year schedule instead of the traditional 27.5- or 39-year depreciation schedule of real property. The results will greatly reduce a company’s taxable income and increase its cash flow.
IRS rulings over the past several years and administrative changes have allowed taxpayers to take advantage of these previously understated depreciation expenses on property already in service by utilizing a change in accounting methods that no longer requires the need to amend tax returns. New construction, buildings purchased in the current year, or any building placed in service after 1986 are eligible. Substantially large lease-hold improvements are also eligible.
What does a cost segregation study do, and how can it help a business?
Cost segregation uses an engineering-based study and analyzes construction documents, blueprints, invoices and other relevant information to determine which components of the facility can be depreciated over a shorter time period.
As instructed by the IRS Code, commercial real property must be depreciated over 39 years. Many of the components can be classified as personal property and depreciated over five, seven or — in the case of land improvements — 15 years. By depreciating personal property and land improvements over shorter lives, a company is able to recognize significant deductions and tax savings on its current and future tax returns.
What qualifies for a shorter depreciation?
Cost segregation studies the components of real estate, separating out personal property that qualifies for a shorter depreciation life, including equipment, machinery, computers, carpeting, cabinetry, special lighting, generators, landscaping, parking lots, windows, site preparation, razing of an existing structure, cabling, subfloors and much more.
What do you need to get started?
It’s very easy for companies to obtain an initial cost analysis and an estimate of savings. If it’s an existing structure, the cost segregation specialist will need a description of the building, capitalized costs and current depreciation schedules. In the case of new construction, the developer or investor group usually works directly with the specialist near the end of construction to analyze construction costs, blueprints and specifications. Eventually, construction invoices, depreciation schedules, appraisals, a site inspection and photographs of construction components also will be needed.
How have recent tax law changes affected cost segregation?
Beyond tax refunds to individuals, there was one substantive pronouncement of the Economic Stimulus Act of 2008. It altered Section 179 to increase ‘immediate depreciation expensing’ to $250,000 per year from $125,000 and to restore a 50 percent bonus depreciation. Those new pronouncements only apply to new construction and new, major remodeling.
But, what they do is enhance the value of implementing a cost segregation program. If you’re doing a major remodel or constructing a building this year, you would be absolutely remiss if you didn’t perform a cost segregation study. It would be a major, major oversight.
How has the green movement in construction affected cost segregation?
Organizations today are being more environmentally conscientious, even though the materials for ‘green’ buildings are more expensive. But, if you go down that path, there are more components that qualify for shorter depreciation lives, like solar-energy panels. I should mention that other tax credits not pertaining to cost segregation are also available if you build green.
PETER A. BELLINI, CPA, is a principal in the tax department at Skoda Minotti. Reach him at email@example.com or (440) 449-6800.