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What is a Cost Segregation Study?

Cost Segregation is an IRS-approved application by which commercial property owners can accelerate depreciation and reduce the amount of any taxes owed. Cost segregation consists of re-classifying components and improvements of a commercial building from real property to commercial property. This process allows the assets to be depreciated on a 5, 7, or 15-year schedule instead of the traditional 27.5 or 39-year depreciation schedule of real property. Thus the commercial property owners taxable income is greatly reduced because a larger depreciation expense deduction is created. Ultimately this improves the building owners cash flow and allows them to reap the benefits of depreciation up front.

How did Cost Segregation come about?

In August 1997 the Hospital Corporation of America owed the IRS $800,000,000 in taxes. This case (Hospital Corporation of America v. Commissioner, 109 TC 21 (1997)) was the ground breaking case for cost segregation. On August 24th, 1997 Judge Tom Wells permitted Hospital Corporation of America to use cost segregation with respect to a multitude of improvements in their commercial building which allowed them to distinguish between components that constitute IRC section 1250 class property (real property) and property items that constitute section 1245 class property (tangible personal property).

Why have I not heard of Cost Segregation?

When Cost segregation first became available as a tax planning strategy it was only performed by the major accounting firms with in-house cost segregation departments on the largest of properties of their most significant clients. One study originally cost upwards of $100,000. 

Even today if you are currently using a local accounting firm or smaller CPA firm they probably are not offering cost segregation services as they may not have the resources available to provide a cost segregation study as the IRS does require that an engineered study be performed.  More likely than not the smaller CPA firm does not keep an in-house engineer on staff to perform cost segregation studies.

How do I know if my property qualifies for a cost segregation study?

Basically if your property was bought, constructed or remodeled after January 1, 1986 you have the ability to have a cost segregation study applied to your commercial property.

When should a cost segregation study be done?

It is best to have a study completed for the year the building or improvements are placed in service. However, IRS Revenue Procedures allow taxpayers to "catch up" on the depreciation that was not claimed from the first day the property was placed in service without amending prior years' tax returns. Furthermore, the IRS recently allowed for the "catch up" period all in the first year rather than over four years, when the Revenue Procedure 99-49 was first introduced.

How does a cost segregation study work?

Building costs are generally classified for federal income tax purposes into three categories; (1) Tangible Personal Property, (2) Land Improvements, and (3) Real Property. Each has a different recovery period and method under the Modified Accelerated Cost Recovery System (MACRS). The qualified engineers who perform the study will have an in-depth knowledge of construction methods, materials, and building components and will perform a detailed analysis of your commercial property to identify the building components and improvements that will be reclassified to take advantage of accelerated depreciation.

This information will then be communicated to your CPA so that they can book your depreciation accordingly and notify the IRS of a change in your accounting methods.

Will a cost segregation study trigger an audit?

If a cost segregation study adheres to and is done in accordance with the IRS Cost Segregation Audit Technique Guidelines then the IRS will not question your cost segregation study.

If a study is performed outside these guidelines an audit could potentially be triggered and the IRS could dispute your accounting methods and take back any deductions taken in error.

If you are going to have a study done tt is imperative that you have a qualified third party perform the study in order to avoid an IRS audit.

To learn more about the Cost Segregation click on the following link: 

http://af.costsegserve.com/