Increase Your Cash Flow for Your Commercial Buildings with Cost Segregation
This article was original published for the Talkin’ Green column in the Lake Geneva Regional News Real Estate Guide. Download a copy of the column from the Lake Geneva Regional News Real Estate Guide.
Consider this: if you own a commercial building and it’s depreciating on a conventional scale of 27.5 to 39.5 years, a cost segregation study can change 20 to 50% of your building’s components to depreciate in 5, 7 or 15 years, simply by re-categorizing some of the existing components.
Cost Segregation: It’s an Approved IRS Procedure
A cost segregation study is an engineering and accounting study that can increase your cash flow with the reduction of your income tax liability by utilizing shorter depreciation periods in order to accelerate the return on capital from your property investment. Whether it’s new construction, a building purchased over the past several years, a major renovation getting started or recently completed, the components of your building can be classified with cost segregation into shorter recovery periods for computing depreciation. Bottom line: if you bought it, built it, or did a major renovation and paid income taxes, this program will work for you. The only way this program wouldn’t be a good fit is if you acquired the building as part of an exchange or you’re planning on selling within 5 years.
There have been literally thousands of cost segregation studies performed and there are good rules of thumb on the tax savings potential by accelerating depreciation. A preliminary review can give you a good idea of the potential savings that could be available. The first key is the building type such as hotel, apartment building, car dealership, etc. The second is the actual cost of the building that you purchased or did a major renovation on. The cost of the land is subtracted so only the cost of the building is reviewed. Third is a review of your current depreciation schedules. According to the IRS, in order to take advantage of this program, you will need to hire a 3rd party firm to perform the Engineering Cost Segregation Study.
Steps of Cost Segregation
- The firm will review your current tax status and plans to determine the benefit of a Cost Segregation Study. Basically, if you have income tax liability, there could be great benefits in going forward.
- The firm will evaluate the construction costs by the various components such as HVAC, electrical, fire sprinklers, mechanical systems, walls, carpeting and finishes for example. The more complex the systems are or elaborate the decorating finishes, the greater the opportunity to accelerate depreciation benefits. There will also be a review of the construction documents, including as-built drawings and project specifications.
- Included in the study will be an actual visit to your building to identify how all of the components are utilized – this site visit is also to document the systems for the final report.
- The firm will then create a detailed engineering report of components and systems including covering special purpose mechanical and electrical systems, decorative finishes, site improvements, and any process related to special purpose construction. The building components will be reclassified into the appropriate depreciation schedule as prescribed by IRS guidelines and direct and indirect costs will be allocated to each component to establish the correct basis.
- The final engineering and accounting report will detail the tax depreciation schedules as well as the forms required to refile tax returns according to the Cost Segregation study.
Is Cost Segregation Right for You?
Although the Cost Segregation study could be done for technically any building, the cost of engineering review, site visits, and accounting tend to not be cost effective for lower cost buildings or simplified property types like self-storage buildings. If you own a profit company that has an income tax liability for a building that is new construction, new purchase or a major renovation costing $500,000 or more, you are a good candidate for a study.
By accelerating 20-50% of your building’s asset value from 27.5 to 39 years down to 5 to 15 years, those depreciation deductions will contribute to your bottom line today. Let’s face it, if you are over 55 years old, what good does 39 years of depreciation do for you compared to tax benefits today?
Cost Segregation can increase your cash flow, save on near term taxes, and help grow your business. But don’t run down to your local CPA firm to get it done. CPA firms typically do not have engineers and construction specialists as part of their business offering. Cost Segregation is an engineered tax solution but might be well worth your time investigating.
*Disclaimer that the above article is not meant to be legal, engineering or tax advice. Alternative Utility Services can refer you to Cost Segregation firms if you are interested.