A cost segregation study is a critical tool for identifying property tax deductions. The analysis can result in “found money” by way of accelerated tax depreciation deductions that can infuse cash into your business. Cash flow is especially important in tough economic times when credit is not readily available.
Essentially, a cost segregation study is a method of analyzing a property’s deductible pieces and parts and segmenting accelerated depreciation opportunities. Rather than classifying a property as a “building,” which typically means a 39-year depreciation period, a cost segregation study separates every component of the structure: lighting, fixtures, equipment, systems and land improvements.
“You can depreciate those items over shorter periods of time — five, seven or 15 years,” says Robert Oulahan, director in the Tax Strategies Group at Kreischer Miller.
By coupling these cost-segregated tax advantages with deductions earned for investments in energy efficiency, a business can realize a substantial ROI. The key is to involve an experienced accountant and respectable engineering firm from the start.
“An engineer-based study pulls out the extra nickels and dimes from a depreciation standpoint,” he says.
Smart Business spoke to Oulahan about the ins-and-outs of cost segregation studies.
Why is now a good time to perform a cost segregation study, and what does the process involve?
First, recent tax legislation related to ‘bonus depreciation’ allows a taxpayer to get even more depreciation benefits for property reclassed into five- or seven-year property. For example, a five-year asset eligible for bonus depreciation would have 60 percent of the assets cost-deducted in year one versus 20 percent without bonus depreciation. Second, cost segregation studies have been available for years, but recent energy-efficiency deductions can add more value to a study. The good news: It’s not too late to begin the process and realize benefits for the 2008 tax year. Most tax-planning strategies must be implemented by Dec. 31, but not cost segregation studies. They can be performed up until the extended due date for tax returns. The process involves a detailed property analysis performed by a reputable engineering firm. Your accountant and engineers collaborate to identify depreciable assets within the property. You receive a detailed, itemized report that ultimately reclassifies the building for tax-advantage purposes. The key to an effective cost segregation study is that it must dig deep. Engineers will often begin with a property blueprint to carve out every deduction opportunity.
At what point should a business enlist an engineering firm to analyze a property?
The earlier the better. If you are constructing a new building, discuss the study with your accountant during the design process. When the architect, accountant and engineer are involved in project planning, tax advantages can be built into the project. For instance, an architect may recognize that by specifying a certain building material a business can earn an energy tax deduction, or an engineer may point out that a certain method of lighting or heating the building could result in more tax savings. When performing a cost segregation study on an existing building — one in service for seven years or less yields the greatest benefits — this team can advise on future building improvements while it analyzes current depreciation possibilities. If the property is older and you are ‘catching up’ on depreciation opportunities, your accountant may amend tax returns or execute a change in method to accelerate depreciation benefits not realized in prior years.
What properties benefit then, and how much can they expect to ‘earn’ via accelerated depreciation?
There are a wide range of properties that benefit from a study. New construction, lease-hold improvements, existing property placed into service in the last seven years (approximation) and inherited properties all qualify. Businesses that greatly benefit from these studies range from auto dealerships with multiple garages, large manufacturing facilities, restaurants, office buildings, apartment buildings and even golf courses. Generally speaking, the return on investment for these studies is anywhere from 10-to-1 to 50-to-1 — that’s 50 times the dollar amount spent on the study. Companies may spend $10,000 for the study or upward of $70,000. That all depends on the size and complexity of the property. The benefit, of course, is the immediate cash potential.
What tax deductions are available for businesses with energy-efficient properties?
This is where cost segregation studies really begin to add up in terms of deductions. With today’s energy credits, companies can basically layer their deductions — meaning a business may claim up to a $1.80 per-square-feet tax deduction on an energy-efficient property. Deductions depend on the property’s lighting, HVAC and building envelop. Also, state and local tax deductions for energy efficiency can pay off for a conscious business — one that plans its building with a team that understands cost segregation practices. Finally, segregating a building’s components into its depreciable parts puts time on a business’s side, as far as depreciation goes.
There has never been a better time to enlist in a study because there are a significant number of deduction opportunities available for businesses.
ROBERT OULAHAN is a director in the Tax Strategies Group at Kreischer Miller. Contact him at (215) 441-4600 or firstname.lastname@example.org.