Property asset classification
Analysis of capital expenditures is used to determine appropriate asset classifications. Cost segregation identifies building costs that would typically be depreciated over a 27.5 or 39-year period and reclassifies them to permit a shorter, accelerated method of depreciation for certain building costs. Costs for non-structural elements, such as wall covering, carpet, accent lighting, portions of the electrical system, and exterior site improvements such as sidewalks and landscaping, can often be depreciated over five, seven or 15 years, rather than over 27.5 or 39 years.Eligibility
Real property eligible for cost segregation includes buildings that have been purchased, constructed, expanded or remodeled since 1987. A formal engineering based study is typically cost-effective for buildings purchased or remodeled at a cost greater than $750,000. A cost segregation study is most efficient for new buildings recently constructed, but it can also uncover retroactive tax deductions for older buildings which can generate significant short benefits due to "catch-up" depreciation.Cost segregation study process
"A cost-segregation specialist can perform a nonintrusive yet detailed engineering study of a building's walls, flooring, and ceilings; and its plumbing, electrical, lighting, telecommunications, heating and cooling systems" (Money Doesn't Grow on Trees, But It Could be Hidden in the Walls By William J. Barnes, CPA). Usually, a construction engineer will analyze architectural drawings, mechanical and electrical plans, and other blueprints to segregate the structural and general building electrical and mechanical components from those linked to personal property. The study also allocates “soft costs,” such as architect and engineering fees, to all components of the building. "In general, a study by a construction engineer is more reliable than one conducted by someone with no engineering or construction background. However, the possession of specific construction knowledge is not the only criterion. Experience in cost estimating and allocation, as well as knowledge of the applicable law, are other important criteria. A quality study identifies the preparer and always references his/her credentials, experience and expertise in the cost segregation area" (www.irs.gov - Cost Segregation Audit Technique Guide - Chapter 4 - Principal Elements of a Quality Cost Segregation Study and Report).Tax benefits of cost segregation
In addition to providing lower taxes, cost segregation can benefit businesses in a number of ways: # Maximizing tax savings by adjusting the timing of deductions. When an asset's life is shortened, depreciation expense is accelerated and tax payments are decreased during the early stages of a property's life. This, in turn, releases cash for investment opportunities or current operating needs. # Creating an audit trail. Improper documentation of cost and asset classifications can lead to an unfavorable audit adjustment. A properly documented cost segregation helps resolve IRS inquiries at the earliest stages. # Playing Catch-Up: Retroactivity. Since 1996, taxpayers can capture immediate retroactive savings on property added since 1987. Previous rules, which provided a four-year catch-up period for retroactive savings, have been amended to allow taxpayers to take the entire amount of the adjustment in the year the cost segregation is completed. This opportunity to recapture unrecognized depreciation in one year presents an opportunity to perform retroactive cost segregation analyses on older properties to increase cash flow in the current year. # Additional tax benefits. Cost segregation can also reveal opportunities to reduce real estate tax liabilities and identify certain sales and use tax savings opportunities.Downsides to Cost Segregation Studies
Downsides to cost segregation studies include cost, the triggering of depreciation recapture and understatement penalties for taxpayers that use cost segregation too aggressively.See also
*Notes
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