Cost Segregation

Cost segregation studies have become an increasingly valuable but not commonly understood tax strategy that should be considered by virtually every taxpayer who owns, is constructing, renovating or acquiring a real estate facility. It is an engineeringbased approach to identifying assets within a building that can be reclassified into a much shorter depreciation class than the building itself. Real estate properties (and everything in them) are generally depreciated using a straight-line method over 39- years (27.5-years for residential properties). These properties are defined as real property.

The cost segregation specialist uses an engineering-based approach, as specified by the IRS. Their job is to examine architectural and engineering drawings for potential asset reclassification. A physical inspection may also be performed, if necessary. Cost data, including the contractor's application for payments, change orders, owner incurred cost and disbursements are examined. Direct labor, material components, and indirect costs are allocated based on an analysis of drawings and specifications.

The average net present value of additional cash flow is $200,000 for every $1,000,000 of a 39-year property that is reclassified. Typically between 15-40% of a building's overall costs can be reclassified to one of the shorter cost recovery periods. The actual amount of present-value savings depends on the type of property and its specific construction components.

Although cost segregation has a long history, the basis for today's studies were established by a US Tax Court decision in 1997. In the past years, the IRS has continued to validate, uphold and improve the value of cost segregation studies by enacting the 2002 and 2003 Tax Acts.

We provide proposals at no cost, so a building owner may objectively evaluate potential benefits. Do not assume that your CPA has performed a cost segregation study in conjunction with the filing of your annual tax returns or that it's too late to file one for your existing building. Ask your CPA if an analysis has been performed on your property. If not, discuss getting
a cost segregation specialist involved on your team.