Who may benefit from a Cost Segregation Study?
Any individual or business entity who pays income taxes and owns developed real estate purchased, constructed or improved since 1987 may benefit from a cost segregation study.
Can estimates be used to determine segregated costs?
No. According to the IRS, estimates may not be used to segregate costs from the building. An actual cost segregation study is required and must be performed using a qualified accountant, architect, construction engineer or construction estimator that can provide a definitive audit trail to prove the segregated costs.
Does a Cost Segregation Study generate additional depreciation deductions over the building's life?
No. Total depreciation over the life of the building will not change. A cost segregation study changes the timing of the depreciation deductions, allowing for a greater amount of depreciation to be deducted in the first 15 years of the building's life; and, a significant portion of that will be deducted in the first five or seven years. This is what creates the net present value (NPV) benefit.
Can I benefit if I sell my building in the near future?
Yes. It is arguable that the fair market value (FMV) of most of
the segregated tangible personal property and land improvements can be
deemed equal to the book value (Cost less accumulated depreciation) upon
disposition. Therefore, no gain or loss would be recognized on the
disposition of these assets while most or the entire selling price would
be allocated to building and land. As a result, the depreciation taken
on the land improvements and tangible personal property segregated from
the cost of the building would be recaptured in the form of additional
capital gains taxed at 15 or 25 percent instead of at the highest tax
bracket at which you would have reduced your taxes from the depreciation
deductions.
Is there benefit available from demolished assets in a purchased building?
Yes. If you purchase a building and move operations into it for at least a short while, even as little as a couple of months or so before deciding to renovate, you are eligible to deduct the cost of the demolished assets in the year of demolition as abandoned property. In this scenario, for every $100,000 of demolished property that is segregated and written off in the year of demolition, an NPV benefit of about $30,500 is obtained. If renovation takes place before moving operations into the building, the segregated cost of the demolished assets must be capitalized, and may be spread over the costs of the renovations. In this scenario, at least some of the cost will be spread over segregated 5 or 7 year property, but much will remain classified with the building.
Does the IRS allow a Cost Segregation Study to be performed on buildings that were purchased, constructed or improved prior to this year?
Yes. A cost segregation study can be performed on any building that was purchased, constructed, or improved as far back as 1987. With the recent advent of Rev. Proc. 2002-19, "Catch-up" depreciation is recognized all in the first tax year affected by the study, no matter how much the resulting change to income is. This procedure requires an automatic application for change of accounting method (Form 3115) to be filed in the first year affected by the study. We prepare those necessary forms as part of the study.
Is there a significant likelihood of an IRS audit with cost segregation?
Not according to the IRS. If you engage in a cost segregation study for the year the building was placed in service, there is no additional filing requirement. For buildings placed in service in prior tax years, generally the requirement is an automatic change in accounting method which the IRS has pre-approved per Revenue Procedure 2002-09 (Superseding 99-49, 98-60 and 96-31), with no amended returns required. Bear in mind that you are changing your depreciation method from an incorrect method to a correct method, which is what generates the automatic approval. However unlikely the risk of audit though, there is no guarantee that
Form 3115 will not be audited, and so we provide a clean audit trail to support our findings.
What is required in order to conduct a full-blown cost segregation study?
Generally, for a constructed property we need a complete set of architectural blueprints, your contractor's final application for payment (AIA Document), construction change orders, any relevant invoices that capture cost breakouts for qualifying assets, invoices for additional items not included in the general contract, and a copy of the depreciation schedule showing the costs capitalized from this project, if placed in service in a tax year for which the income tax return has already been filed. For purchased property, we need the escrow statement, a complete set of architectural blueprints, and any documentation or blueprint with respect to any renovation and demolished asset.
How is cost segregation different from component depreciation?
Cost segregation is where the taxpayer is simply identifying and isolating costs for assets that qualify as tangible personal property or land improvements. This differs from component depreciation in that component depreciation was used for the addition of structural replacements on buildings that were placed in service before 1981 where the new component was permitted to be depreciated on an accelerated basis and for a much shorter life span than that of the building. Those same structural components do not qualify for acceleration or shorter life span today, either.
If I don't have architectural blueprints, is cost segregation still possible?
Yes, however, the architect or construction engineer on the cost segregation job will have to conduct the study completely on-site, which will add costs to the overall project. We will do our best to see if we can locate a duplicate set of blueprints. If none can be located, we will let you know of the additional cost to perform the study on-site before you engage us to do the work.
Will I still benefit if I am subject to the passive loss rules (PAL), net operating losses (NOL), or the alternative minimum tax (AMT) or because I am a nonprofit entity that doesn't pay income taxes?
As for the latter, you definitely will not benefit. If you don't pay income taxes, additional deductions will not help you. As for the other three, however, if you have income from other passive activities against which to offset passive losses, then the losses generated by the building are currently deductible. Also, if you lease your building to a business that you own and materially participate in, if by leasing the building to your business at the highest possible rental FMV you generate rental income, additional depreciation will benefit you to the extent of that income. If an NOL is generated, you may be able to carry the loss back two or more years to years with income and claim an immediate tax refund. If you are subject to the AMT or if a study causes you to become subject to the AMT, you will still benefit from a cost segregation study, just not as much, as long as you are not limited by PALs or NOLs. We can incorporate AMT scenarios into our projection. AMT lives are the same as regular tax lives since 1999, only the acceleration is lessened, e.g., 200 percent declining balance becomes 150 percent. Before 1999, the lives were different, e.g., 5-year property was 9-year property for AMT. Even so, it is better to get 9-year treatment at 150 percent declining balance than 39 or 40-year treatment at straight line. Please consult your CPA or tax advisor to assist you in determining how any of these scenarios would impact your taxes.
Would it be worthwhile to wait for a cost segregation study in the future?
Since the benefit from cost segregation is based on the time value of money, the longer you wait, the more NPV benefit you forfeit.
How is the projected NPV benefit determined in advance?
You or your CPA simply provides us with certain information that we will request, and using historical percentages of similar property, we will provide you with a complimentary feasibility analysis that will show your projected NPV tax savings with a year-by-year breakdown of the change in cash flows.
Is cost segregation possible for §1031 like-kind exchange-acquired buildings?
Yes. Even though §1245 tangible personal property is segregated from the total for income tax purposes after the exchange, as long as state law provides that all assets obtained in the trade qualify as "realty," there will be no gain recognized on the exchange. This would be the case in most states. For example, even though certain plumbing qualifies as tangible personal property, it is still considered realty with respect to state real estate law. When you trade a building, the §1245 tangible personal property costs which have already been segregated, no gain would be recognized on trade if the FMV of the §1245 tangible personal property traded was no greater than the adjusted basis of those assets--which will almost always be the case. Think of it this way: "What would the FMV of used plumbing be?"
Will I benefit if tax rates are reduced or if the income tax code is repealed?
If this happens, you benefit even more! This is because you will recognize significantly greater depreciation now while the higher rates are in effect. In the later years, you will recognize less depreciation generating a negative cash flow as a result of front-loading additional depreciation in the early years. If the tax rates are lower in the later years, then this negative impact in those later years is mitigated; if the income tax code is repealed, then this negative impact in those later years is completely eliminated! And if a cost segregation study has not been prepared, you forfeit much depreciation expense for which a tax benefit will never be realized.
Is there a minimum building cost required for a cost segregation study? What assurance is there that the NPV benefit will exceed the cost of this study?
There is no minimum building cost required. We will provide a complimentary feasibility analysis to estimate the NPV of deferred taxes you can expect from a cost segregation study of your building. Since this analysis is free, there is no reason not to examine any building. And simply put, if we find that our NPV estimate is not significantly greater than our fees, we won't do the job.
How much in NPV of deferred taxes can I expect?
Based on historical averages, for every $1,000,000 invested in total building costs, approximately $50,000 of NPV of deferred taxes can be expected. This amount will vary depending on the type of building, when it was acquired, and your marginal federal and state income tax brackets. Put another way, for every $1,000,000 of building costs that are classified as tangible personal property and depreciated over five years using MACRS, approximately $250,000 is realized in NPV of deferred taxes -- $225,000 for seven-year property and $130,000 for 15-year land improvements.
When can I expect a return on my investment in a cost segregation study?
Immediately!! In most cases, the tax savings in Year 1 will far exceed the entire cost of the study. What's more, the fees are entirely tax deductible!
How do I benefit from an OGL cost segregation study?
- We pay close attention to detail, and we do not classify any asset to a shorter depreciation life for which we feel we cannot provide sound argument.
- We present our report in an easy-to-follow format, making your CPA's job of creating your new or revising your old depreciation schedule a simple task.
- In our report, we provide a reconciliation of contract costs to the depreciation schedule and studied capitalized costs, if applicable. This provides a clean audit trail and may find additional assets qualifying for faster recovery and accelerated depreciation. This may require the assistance of your CPA or in-house accounting personnel.
- We prepare certain statements and attachments supporting the § 481 (change in accounting method) adjustment, if applicable, for regular tax and AMT as well as adjusted current earnings (ACE) for C-corporations or partnerships, if applicable. We also account for mid-quarter convention, if applicable.
- We have a comprehensive feasibility analysis program that accounts for
various situations, including the mid-quarter convention and anticipated sale, and is set up to provide
an accurate NPV projection while incorporating the newly enacted declining income tax rates between 2001 and 2006.
- We work closely with your CPA or controller in order to assist them in completing their task efficiently and accurately.
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