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Cost Segregation
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Cost segregation is a highly beneficial and widely accepted tax planning strategy utilized by commercial real estate owners and tenants to accelerate depreciation deductions, defer tax, and improve cash flow. Once used only by big-4 type accounting firms and the nation’s largest real estate owners, this practice has become routine for commercial property owners of almost every size.
A cost segregation study (CSS) is based on a detailed engineering analysis that is used to support the acceleration of depreciation deductions by identifying costs that can be allocated to shorter recovery periods; primarily 5, 7, and 15-year, as opposed to 27.5 (residential rental) or 39-year (commercial). A quality study provides the documentation needed to defer substantial tax payments and greatly improve cash flow. It is important to note that a cost segregation study does not create new deductions, but increases deductions in the early years of ownership. This front-loading of depreciation allows the taxpayer to take advantage of the time value of money.
Visit our Project Profiles section to view real life examples of the incredible savings.
Benefits
There are a number of benefits associated with cost segregation and its various applications. The primary benefit of course is significantly improved cash flow. This is most often achieved through the acceleration of depreciation deductions and the resulting tax deferral. In addition to the impact of accelerated depreciation, cost segregation may also allow for…
• Reduction of estimated quarterly tax payment
• Property tax savings
• Transfer tax savings
• Lower insurance premiums
When prepared correctly, a cost segregation study can also be an excellent asset management tool. To learn more about using cost segregation throughout the life cycle of real estate, and the additional benefits that may be available please visit our Applications section.
Qualifying Properties
Any type of commercial or residential rental property, of any size, placed in service after December 31, 1986 will qualify for a cost segregation study. However, the cost / benefit analysis may prohibit lower valued properties from being good candidates for a cost segregation. Typically, cost segregation starts to make sense for properties that have a depreciable cost basis of $1 million or more, although there are certainly exceptions. This value drops to the $250,000 range when considering cost segregation for a tenant improvement project.
While property owners and their tax advisors routinely use cost segregation following completion of a new building or acquisition of an existing building, there are additional applications for this strategy that apply to the various stages of real estate ownership and development.
• New Construction
• Existing Properties
• Acquisitions
• Redevelopment
• Leasehold Improvements
• Other Uses
History
Cost segregation is an offshoot of component depreciation which was used from 1959, when the tax court recognized the right of the taxpayer to calculate depreciation using a component method (Shainberg vs. Commissioner), until it was "disallowed" by the Tax Reform Act of 1986. Since the TRA of 1986 there have been a number of court cases that ruled in favor of cost segregation, the most notable being the 1997 Hospital Corporation of America case (HCA v. Commissioner) in which the court ruled that the definitions of personal property, as previously developed by the courts during the investment tax credit (ITC) era, are still good law. The HCA case served as a landmark decision for cost segregation, providing the legal support to use cost segregation studies to compute depreciation.
On April 30, 2004 the IRS released the first version of the Cost Segregation Audit Techniques Guide (ATG). This document was designed to provide IRS examiners with a better understanding of cost segregation studies. The ATG outlines the legal framework for cost segregation, various methodologies being used, elements of a quality study, elements of a quality report, and provides industry specific guidelines.
The ATG also makes reference to the qualifications of a cost segregation provider stating "a study by a construction engineer is more reliable than one conducted by someone with no engineering or construction background" and "a quality study identifies the preparer and always references his/her credentials, experience and expertise in the cost segregation area".