There May Be Huge Tax Savings in Your Walls: Is a Cost Segregation Study Right For You?

8/30/2012 - By John Mascaro, CPA

Would you invest $10 to get an immediate potential return of $100? Of course you would.

Would you call your CPA to find out what your estimated benefit might be if you could get that initial estimate for F-R-E-E? Of course you would.

While the above $10 for $100 example is for illustrative purposes and your actual benefit may vary, that's typically the cost benefit achieved when a cost segregation study is used to properly re-classify costs of a purchase or construction of a commercial building used in your trade or business or rented to others. And frankly, our experience shows that the benefit described above is not far from reality.

How It Works

A cost segregation study is an analysis of buildings overall costs performed by an engineering firm specializing in such IRS based studies, and conducted in coordination with your CPA. Its main purpose is to more properly classify and quantify how much of the costs of a commercial building can be depreciated over much shorter "recovery periods" e.g. 5, 7, 10, 15 years than the 27.5 or 39 year periods required by tax law for mere "real property" used in a trade or business.

Because a cost segregation study is often conducted after-the-fact of acquisition or construction of a commercial building, it is more often focused on "re-classifying" costs to more appropriate shorter recovery periods than those that were previously "capitalized" (recorded on your financial statement balance sheet) as a long term asset initially thought to be depreciable over 27.5 or 39 years.

Under IRS guidelines, a cost segregation study must be performed by a reputable engineering firm with expertise in this highly specialized area of tax.

Merely having your bookkeeper or current accountant classify costs into shorter depreciation periods does not ensure that those reclassified costs meet the strict IRS tax standards which are based on engineering criteria which only a competent engineering firm can provide.

That's where we come in. Saltmarsh partners with one of the leading engineering firms in the United States, "Cost Segregation Strategies Inc" ("CSSI") ,to conduct its cost segregation studies. Indeed, back in 1997, CSSI's founder was retained to assist the lawyers win the landmark watershed tax case involving cost segregation in The United States (Hospital Corp of America "HCA" 109 TC 21 (1997).

So... when you come to Saltmarsh for tax deductions from cost segregation, you have the best accounting, tax, and engineering minds going to work on your project.

Key Point:

The cost segregation study does not generate "more" depreciation. It simply accelerates into the current year (and first 5 to 6 years) a portion of the depreciation you would otherwise have taken over longer periods of time.

What Types of Components Qualify?

This reclassification of costs is not of the structural building itself, which is considered "real property" (i.e. real estate), but rather, of various separate components of the building considered to be "tangible personal property" often overlooked by a bookkeeper or prior accountant and simply lumped into longer life property 27.5 or 39 years for the sake of record-keeping expediency. This expediency, however, usually short-changes property owners of cash-saving tax deductions in the early years of the operation of the property.

Examples of tangible personal property components routinely misclassified as "building" includes:

Equipment or systems used to generate multiple power sources
Certain walls if they penetrate ceiling tiles or if they are load bearing
Decorative paneling that is glued, nailed, or hung on the walls of your reception area and conference rooms
Heating or cooling systems or refrigeration dedicated to specific areas such as data-processing room or restaurant or commissary
Dedicated kitchen equipment
Certain flooring related costs
Plumbing systems
Electrical systems
Lighting systems
Telecommunications systems

The above is just a small sample of qualifying costs.

What Types of Buildings Benefit Most?

You name it!

Here are just some examples of the types of commercial and investment properties that benefit:

Airports, Apartment buildings, Assisted living facilities, Automobile dealerships
Bank branches
Casinos, Cinemas
Day care facilities, Department stores
Fitness centers, Food processing facilities, Funeral homes
Gas stations, Golf courses, Grocery stores
Hospitals/medical centers/physician practices, Hotels/motels
Industrial facilities
Laboratories
Manufacturing facilities, Marinas, Medical facilities, Mixed-use facilities
Nursing homes
Office buildings
Parking lots, Pharmaceutical, Public utilities
Research facilities, Retail centers, Resorts, Restaurants
Shopping centers, Sports facilities, Storage facilities
Warehouses and distribution centers

The adjustment from a cost segregation study often has a dramatic impact on your bottom line! For example, a successful cost segregation study will produce approximately $50,000 to $100,000 of immediate cash flow for every $1 million of commercial building cost by way of the tax savings attributable to the accelerated depreciation.

**The image above shows some relative benefits derived for different types of properties based on a compilation of projects stemming from 2005

It Gets Better!

Saltmarsh and CSSI will provide you with an initial estimate of your potential tax benefit free of charge! You can assess the pros and cons and decide to proceed or not at no cost to you.

But It Gets Even Better Than That!

Should you proceed with your cost segregation study and the IRS challenge the reclassification of costs in an examination, CSSI will defend your cost segregation study performed in your behalf FREE OF CHARGE! That's right - free audit defense of your study if challenged by IRS.

So...the only question left is: what are you waiting for?

John Mascaro, CPA is a Senior Manager in the Tax & Accounting Service practice at Saltmarsh, Cleaveland & Gund in charge of tax research and planning. He is licensed in Florida and New York State.

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