What is a Cost Segregation Study?
An engineering-based cost segregation study is an in-depth analysis performed by qualified individuals skilled in engineering, construction, and taxation for the purpose of identifying the individual building assets, their associated costs, and appropriate recovery period classification for federal, state, and property taxation.
Typical building costs are broken down into three categories: Structural components or real property, tangible personal property, and indirect costs and land improvements. Each of these categories has a unique depreciation recovery period under the Modified Accelerated Cost Recovery System.
Engineering-based cost segregation studies allow commercial real estate owners, for depreciating purposes, to take what would be classified as real property (1250) of 39 years or 27.5 for commercial residential, and reclassify it as a more rapidly depreciating personal property (1245) of 5/7/15 years.
$$$BENEFIT: This reclassification is what generates cash flow in both current and future years by substantiating a shorter depreciable life and accelerating depreciation; whereby bridging the gap between engineering, construction, and accounting. The time-value of money applies.
A Brief History: Cost Segregation
1962-Enactment of the Investment Tax Credit 1986-Investment Tax Credit act was repealed 1997-Landmark court case, Hospital Corporation of America successfully defended the application of engineering-based cost segregation as a viable method to differentiate real and personal property under existing law. The Modified Accelerated Cost Recovery System (MACRS) has its roots in the Investment Tax Credit. That program was changed to Accelerated Cost Recovery System (ACRS), and then modified (MACRS). The IRS rulings and court cases support the idea that systems which directly serve equipment that qualifies for accelerated depreciation, also qualifies for accelerated treatment. The proper documentation using the engineering approach is required to justify what you claim.
Why do property owners and their CPAs need this service?
Contractors do not break out costs according to tax laws- item costs are usually buried in larger billings. CPAs are generally limited to allocating costs from invoices for specific property components, thereby narrowly identifying the personal property for tax reporting purposes. Your CPA will receive the complete component unit cost detail for your entire property and the documentation allowing them to generate a new depreciation schedule.
A cost segregation study does not replace your accountant’s role in determining taxes. But it does provide your CPA with another valuable tool which will allow them to easily identify future retirements, and/or allow you to claim “catch up” depreciation on previously misclassified assets. If it is a look-back we will facilitate the completion of the Form 3115. No amended tax return filing is required.
The Look-Back You can go back as far as 1987 for a catch-up. Only one “adjustment” tax return form (Form 481) is required. Previous individual year’s returns are not required to be changed. Several recent rulings have been issued by the government to spur economic growth. During 2002, the IRS automatically consented to changes in the method of depreciation via Form 3115, filed with the return in the year the change is elected.
(Rev. Procedure 2002-09) The IRS made it easy to change your method of depreciation without having to amend your return. You can now catch up on all deductions from previous years for items reclassified into the shorter tax lives as a result of a cost segregation study. In 2004, the IRS reversed the two-year waiting period to change the method of calculation for depreciation on your property. You can now change your method of depreciation in any year, without the prior two-year wait rule.
What % of a building can be reclassified?
|Assisted Living Facility||22-45%|