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Practical Applications for CSS - Design & Construction
Publication:
New York Real Estate Journal (August, 2006)
Authors:
Jacob D. Hopper
Bryan Wilson
Although there are many applications
for cost segregation, new construction
projects are often the first
to be considered. Generally speaking,
it’s good to have a cost segregation
study (CSS) performed as soon
as a property is placed into service.
This allows the taxpayer to take full
advantage of accelerated depreciation
Typically, the request to perform
the CSS is made after the building is
completed and placed into service.
While substantial benefits can be
generated by performing a study after
construction, greater benefits can
often be achieved if the cost seg
consultant is involved from the beginning
— during the design phase.
Unfortunately, many owners and
their tax advisors are unaware of this
valuable opportunity. Further, many
cost segregation providers are still
unfamiliar with this application, or
they simply lack the engineering and
construction expertise to address it.
Design Phase
Getting your cost segregation consultant
involved during the design
phase can be very beneficial, especially
on larger or more specialized
projects. Early involvement allows
the cost seg consultant an opportunity
to understand the project and
make valuable suggestions before it’s
too late. While some issues can be
addressed during construction, it is
better to know ahead of time to avoid
unnecessary change orders. Ideally,
you’ll want to make this introduction
after the conceptual drawings are finished,
but before the project goes out
to bid. This will also provide an opportunity
to request the bids in a
format that is more conducive to performing
the study.
The recommendations made during
design will mostly deal with the
types of materials being used and
manner of affixation. Both are important
things to consider from a tax
perspective. Small changes to design
or types of materials can generate
large tax benefits. One classic example
is whether to use paint or some
form of removable wall covering.
Paint is depreciated using a 39-year
recovery period, while removable
wall coverings can be depreciated
over five or seven years. Some
additional design elements to consider
include wall partitions, floor
coverings, lighting, and canopies, to
name a few.
The design phase also provides an
opportunity to check how drawings
are labeled. The intended use of an
asset is a key consideration in determining
whether it will qualify for a
shorter recovery period. Detailed labeling
can help provide a more defensible
position with regard to intended
use. Lighting is a great example
of this. Labeling the panel
schedule of the blueprints to separately
identify base building and accent
lighting provides a clear distinction
with regard to use. Base building
lighting is a 39-year item in the
eyes of the IRS, but accent lighting
can be depreciated over five or seven
years. This is especially important in
properties that have a high percentage
of special use assets, such as
medical facilities, auto dealerships,
restaurants, and manufacturing facilities,
to name a few.
Construction Phase
There are two important elements
of the construction phase from a cost
segregation perspective. First is the
ability to make last minute suggestions
with regard to materials and
installation. Change orders may affect
the initial design and therefore
need to be reviewed. Second is the
documentation process. Building a
defensible position for the classification
of assets is the cornerstone of
a good CSS. Solid photographic and/or video documentation is a key part
of this process. Involvement during
construction allows the cost seg consultant
to document aspects of the
property the will not be visible once
construction is complete. It also provides
an opportunity to document
manner of affixation. This is important
because of the permanence and
adaptive reuse tests used by the IRS.
Closing Thoughts
Getting a cost segregation consultant
involved early can provide
real value, but it can also create some
challenges. It is important that the
cost seg provider be familiar with the
entire design and construction process
so they don’t get in the way. The
last thing the design and construction
teams want is someone to slow
down their progress.
Although it can be tempting, don’t
assume that the architect or contractor
can properly allocate costs or
prepare a defensible CSS. Most architects
and general contractors do
not have any knowledge of the tax
regulations and will not be willing to
defend the taxpayer in the event of an
IRS audit. Spend the extra dollars to
get a real CSS.
The bottom line is that by getting
your cost segregation consultant involved
early on you may be able to
recognize significant tax benefits. A
good cost seg consultant will be able
to identify opportunities and provide
recommendations on how to achieve
the most favorable tax treatment.
