There’s a lot to think about when purchasing a facility for your business, or even constructing a new one. Regardless of how the building is purchased, building owners need to consider the benefits of cost segregation. A cost segregation study could help enhance the tax depreciation associated with the real property.
A cost segregation study analyzes the cost of purchasing or constructing a building and properly allocates the cost into the correct asset classification. This classification is important, as the general rule for the tax depreciable life of a commercial building is 39 years. Therefore, a cost segregation study saves the business owner current taxes by accelerating depreciation using a shorter depreciable life. It is important to note that a cost segregation study does not increase the overall depreciation allowed. However, it is a great tool to accelerate depreciation in the early years of owning a building.
“If you’re going to depreciate the building over time, regardless if you use cost segregation or not, you’ll get more money in your pocket today by saving tax dollars versus depreciating a commercial building over 39 years,” says Tim Schlotterer, CPA, director, tax and business advisory services, GBQ Partners LLC. “Ultimately you’re still going to depreciate the full cost of the building, but it’s just a matter of how quickly you want to and are able to depreciate it.”
Smart Business spoke with Schlotterer about what you need to understand about cost segregation and how to prepare for a cost segregation analysis.
What are some key things you need to understand about cost segregation?
You should consider doing a cost segregation study for any building purchases made over the last 10 years that have not been examined, based on your current tax situation. It may not make sense if you’re in a loss situation. Any taxpayer who owns a building that is profitable should consider cost segregation to reduce his or her tax liability.
How can you prepare for an analysis?
You need to provide the individuals conducting the analysis with some details about the building. This includes drawings of the building and tax depreciation schedules if the building has been placed in service in previous years. If the building is newly constructed, you should provide the final pay application (schedule of values) provided by the general contractor, which documents all costs associated with construction.
What steps should you take after a study is completed, and how can you use that information within your business?
There are two components. If it’s an existing building that you’ve owned for the last 10 years, you need to consider any missed depreciation over the time you’ve owned it. That correction of depreciation can be taken within the current year’s tax return as an automatic change in method of accounting, which gets reported on Form 3115. This correction of depreciation could provide significant tax savings to the building owner, depending on how long the building has been owned. If you have a building you’ve just purchased or built, an owner of the building needs to consider the cost versus benefit analysis and determine if there’s an estimated tax savings. It’s important that the tax savings be done in present value dollars versus over a period of time, so you can better understand what the true dollar value tax savings is in the current year, versus the cost of doing the study itself.
What type of savings can you expect from cost segregation?
It’s difficult to pinpoint. A lot of the savings depends on use of the building. Special use type buildings that are designed or created to support services offered within the building could bring about significant savings. The saving could be as high as 25 to 35 percent of the building being reclassed from 39 years to a lower depreciable life. Even a building that’s just standard use, like a distribution center or warehouse, can still result in a considerable amount of savings anywhere from 10 to 15 percent of additional savings. The amount really depends on the building’s intended use, design of building and cost.
What are the benefits and risks associated with cost segregation?
Cost segregation gives you a present value savings of tax. By doing a cost segregation study, you’re accelerating the tax depreciable life of the building and getting the benefits now, versus over a longer period of time.
Cost segregation is an acceptable process by the IRS. The risk is the professional services firm you use and engage to complete the study. There are many boutique firms out there that will offer this type of service. When deciding on a firm, you need to make sure you have two players involved a good tax professional and an engineer. The engineer should understand building structures and be able to use those skills, and the tax professional should use his or her knowledge of tax law to make sure the proper classification of assets is performed. These two components will provide assurance to the business owner that the cost segregation report will be upheld under an IRS exam.
Tim Schlotterer, CPA, is the director, tax and business advisory services, with GBQ Partners LLC. Reach him at (614) 947-5296 or firstname.lastname@example.org.