Frequently Asked Questions About Cost Segregation
What is a Cost Segregation Study? Not widely known but Cost Segregation Studies or CSS is a tax strategy to more rapidly depreciate real and personal property assets in commercial real estate for both property owners but also companies who have extensively renovated commercial properties. It should be performed under auspices of the “Detailed Engineering Method” specified by the IRS.
The study will look at items such as landscaping improvement, parking lots, lighting and electrical system, floor and wall coverings, plumbing, mechanical systems, and site improvements of a building along with hundreds of other components which can be allocated into shorter lives (5/7/15 years) translating into immediate cash flow.
Why can’t my CPA do this study? The IRS has recommended that CPAs not perform these studies, CSS should be done as aforementioned using the “Detailed Engineering Method” specified by the IRS. Many CPAs are aware of this tax strategy but it’s outside their scope of expertise, to wit, the IRS’s strong verbiage that individual/organization preparing a cost seg study “requires knowledge of both the construction process and the tax law involving property classifications for depreciation purposes.”
I can just hire an engineer to do the study, can’t I? CSS requires a team of members with expertise in construction methods, complex tax laws, appraisers, project managers, and construction cost estimators. We will not take the approach of short-term gain to risk long-term reputation and has gone to great lengths to use the latest tools (including development of proprietary software), methods and procedures to deliver the most detailed and comprehensive reports in the industry, according to strict IRS rulings and requirements.
An important point to point out here is audit defense. Is the person/firm you are hiring going to come to your defense if you are audited? You do not want someone who is not experienced with doing a cost segregation study performing yours and then having to defend you to IRS auditors. With that…
What if I’m audited? And does a CSS increase my chances of being audited? No, having a Cost Segregation Study does not increase your chances of being audited; however, if done incorrectly it could increase your chances to run into an issue. The IRS has specifically issued guidelines and procedures on how CSS can and should be used. For more info, kindly refer to the IRS website here.
We provide UNLIMITED AUDIT DEFENSE at no charge to our clients. We have, with over 6,000 studies completed, never had one of our studies contested by the IRS. We will go to bat for you if you are audited.
We are one of the few firms in the country to perform the RS Means Tolerance Test. This is a comparison of the constructed cost of the building compared to the national average in terms of square foot, cost and percentage of assets within the total cost of electrical, mechanical and personal property elements. If we find significant differences such as 15% electrical versus the national average of 10% for like kind building we will then document the difference to the IRS. Most firms simply guess. Although this takes us a considerable amount of time, we can be much more accurate which leads to greater audit defense and a lot of the time, a larger cash benefit to the client.
Why haven’t I heard of this before? While around since the 1980s costs to conduct Cost Segregation Studies were prohibitive except to only the larger commercial RE developments. A landmark court decision, HOSPITAL CORPORATION OF AMERICA v. COMMISSIONER (“HCA”) (1997) paved the way for not only making CSS more common as info about it spread to CPAs, engineering firms and CSS specialists like us but also made it affordable to almost all owners of commercial real estate and thus more property owners elected to benefit from this tax strategy which, for those who qualify, provides a boon in terms of cash flow.
How much cash are we talking about? On average, our Cost Segregation Study offers approx. $150,000 in additional depreciation per $1 million dollars in purchase or construction cost (excludes land cost) over the normal 39-year straight-line method.
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