Recent IRS rulings and court cases have opened up a new vista for accelerating depreciation, paving the way for property owners to cut taxes and free up cash for money-making projects or investments.
Generally, businesses have been limited to depreciating commercial real estate over a lengthy 39-year period and residential property over a slightly shorter 27 1/2-year period. In appropriate circumstances, however, these time frames can be considerably shortened with a cost-segregation study. The IRS issued a memorandum in 1999 allowing the classification of building costs into different categories, allowing for cost segregation studies to facilitate tax saving opportunities.
A cost segregation study separates nonstructural costs from structural real property costs, facilitating depreciation of a business's personal property and land improvements over a much shorter time period. As a result, more depreciation can be taken upfront. The major areas of cost allocation are electrical, plumbing, site work, HVAC and millwork.
How can cost segregation studies benefit you? They can:
* Reduce corporate or individual income taxes in the near term.
* Help provide corporations and investors with increased cash flow.
* Provide investors with additional cash to reinvest in new projects.
* May allow for future write-offs when structural components are replaced
* Allow taxes to be deferred, not eliminated
The actual amount of real savings and other benefits depends on the type of property and its specific construction expenditures, but most facilities can derive some benefits. An estimated after-tax savings of 5 percent of an asset's depreciable basis can usually be realized annually over the first 10 years of the depreciable term, but after-tax savings as high as 15 percent for certain property types are not unusual.
Cost segregation studies can be done for newly acquired, newly constructed properties and for existing buildings that are undergoing renovations or expansions. The tax savings resulting from the cost segregation process will vary depending upon the size and type of property involved.
However, it is not unusual that 20 percent to 40 percent of a project's costs can be reclassified as personal property and land improvements, which have far shorter depreciable lives.
Manufacturing facilities, hotels and office buildings, as well as high-end tenant improvements, are generally good candidates. However, properties with extensive site preparation work and personal property, such as big-box retailers, warehousing and distribution centers, self-storage facilities and multifamily buildings, are also excellent candidates for cost segregation depreciation benefits.
To qualify, the property must have been acquired, renovated or improved after 1986.
What is required in a cost segregation study?
* A detailed analysis of the direct and indirect construction, improvement and renovation costs, and an examination of drawings, blueprints and specifications, if available
* A physical inspection to observe and identify property utilization
* An expert's understanding of specific building, mechanical and electric systems, as well as the processes characteristic of certain types of assets
* A detailed knowledge of the tax code as it applies to the cost segregation process
As many property owners can testify, cost segregation can bring numerous benefits to a company and its owners. If you look hard, you, too, may find cash in your building. Stephen J. Ritmiller is director of the Real Estate Services Group for Alpern Rosenthal. Reach him at (412) 391-0812 or firstname.lastname@example.org.