to Cost Segregation
A compelling tax savings
for real estate owners
We can typically assist in recovering
at 10 cents or more for every dollar you spend on new construction
or a purchased building using IRS-compliant accelerated tax depreciation.
A cost segregation study carefully
breaks down your construction or acquisition costs and allocates
them to specific categories - maximizing accelerated depreciation
for qualifying personal property. The shorter the depreciation period,
the greater your tax savings. This study could also be used to provide
the basis for your property records system. In addition, certain
construction costs do not add to value and should be excluded from
the property tax basis. These may involve overtime, demolition,
Although the optimal
time to begin a cost segregation study is when plans to build, remodel,
or expand a building are first drafted, eligibility extends
and facilities that have been newly constructed since 1987.
facilities constructed before 1986, but acquired in a taxable
transaction after 1986.
and additions completed after 1986.
The first step is the segregation of the project costs into specific
asset groups. The costs to be segregated include the actual direct
costs of construction or acquisition and the indirect or “soft
costs” (i.e. legal, architectural, engineering fees, appraisals,
construction management, etc.) The second step is categorizing the
assets based on the appropriate depreciable lives for income tax
By identifying, segregating,
and reclassifying costs related to 5, 7, 15, and 20 year property
from the 27.5 or 39 real property categories, such property can
be depreciated over a much shorter time frame. In addition, the
5, 7, 10, 15, and 20 year property classes are depreciated using
accelerated methods, which further increase the deductions in early
Critical to establishing this
significant cash benefit is a detailed engineering analysis. We
provide complete cost analysis and supporting documentation. Our
engineers understand accounting and tax codes as well. They perform
quantity take-offs from construction drawings or available data
for purchased buildings. The key to withstanding IRS scrutiny is
a thorough application of engineering standards and our prior successful
negotiations with the Treasury. We do not merely rely on broad percentage
allocations or contractors lumped costs.
If you depreciate newly constructed
or purchased buildings over a 39 year tax life (27.5 years for residential
rental real estate), you have left cash in the building. You can
recover on average of 10 cents of every dollar in the building account
by accelerating tax depreciation from shorter lived personal property
and site improvements.
The primary authority for this
segregation of building costs is Revenue Procedure (Rev. Proc.)
87-57, 1987-2CB687, which provides comprehensive instructions and
depreciation rate tables for computing depreciation available under
Code Sec. 168, as amended by Act Sec. 201(a) of The Tax Reform Act
of 1986. These depreciation tables are known as MACRS, Modified
Accelerated Cost Recovery System.
Structural components of a building,
as defined in Regulations Section 1.48-1(E)(2), include such items
as walls, partitions, floors, HVAC, plumbing and plumbing fixtures,
etc. and other components relating to the operation or maintenance
of the building. Excluded from the definition is machinery or processing
materials or foodstuffs.
In contrast to the above definition,
Code Section 148-1(C) defines tangible personal property as “any
tangible property except land and improvements thereto, such as
buildings or other inherently permanent structures.…”
Tangible property includes all costs (assets) that are necessary/accessory
to the operations of the business. Examples include:
purpose area (e.g. clean rooms)
||Primary and secondary
electrical distribution systems where the electrical load is
carried to equipment, telephone equipment, internal communications
floor coverings and accordion doors/partitions
millwork and removable vinyl wall coverings
Special rules incorporated from Rev. Proc. 83-35, sections 2.02
(iii) and (iv) define Asset Guideline class 00.3, Land Improvements,
as “other tangible property”. Thus, costs for site improvements
should be removed from construction or acquisition costs and put
into this account.
In order to claim underreported
depreciation for prior years, the taxpayer may request an automatic
change of accounting method. The authority for this claim is Revenue
Procedure 99-49. The missed depreciation may be claimed over the
four ensuing years (Section 481 adjustment). The cost segregation
analysis can be used for buildings placed in service as far back
as 1987, even if the year is closed for tax purposes.
Two court cases support the determination
of personal property apart from structural components. The most
recent is H.E. Butt Grocery Company (2000), which reinforced the
claim of added depreciation based upon a cost segregation study.
The second and most critical is Hospital Corporation of America
v. Commissioner (1997), which provided clear evidence of what the
courts consider tangible personal property versus structural components.