Cost Segregation Study Can Accelerate Deductions

For Real Estate Owners

By Mario Cherubino, Jr., CPA


Real estate owners can benefit from the proper allocation of costs through a cost segregation study.  Typically a real estate owner can receive $110,000 net present value savings on a $2,000,000 facility by allocating $500,000 of costs to assets using accelerated depreciation methods over shorter lives.

In a recent tax court decision Hospital Corp. of America (HCA) v. Commissioner, HCA was able to accelerate depreciation deductions by classifying a portion of a Hospital facility as tangible personal property instead of non-residential real property.  Based on various tax court cases and Internal Revenue Service guidance, it is necessary that a taxpayer have a cost segregation study to allocate a building's costs properly.  A cost segregation study should be prepared on a current basis and not from reconstructed data or taxpayers estimates that have no supporting records. While preparing a cost segregation study it is very important to distinguish structural components relating to the operation or maintenance of a building, from components related only to equipment used in building.  Generally, a commercial building is depreciated on a straight-line basis over 39 years.  Tangible personal property, which includes machinery & equipment, is generally depreciated on a accelerated basis over 5 to 7 years.

Increasing deductions in the earlier years through shorter lives and accelerated depreciation methods can increase cash flow in those years while producing a permanent net present value savings.  The following example illustrates the benefits of a cost segregation study.  Assume that a company placed a facility in service on January 15, 2003.  The facility had a total cost of $2,000,000.  The cost segregation study allocated $1,500,000 to commerical real estate (39 year property), $400,000 to personal property (7 year property) and $100,000 to land improvements (15 year property). 

The allocation of $400,000 to personal property and $100,000 to land improvements could potentially save the company $112,085 on a net present value basis.  These savings assume the company's effective federal & state tax rate is 44% and the company expects an 8% rate of return on tax savings realized in the earlier years.  The potential tax savings realized in this example is determined by comparing depreciation without a cost segregation study ($2,000,000 depreciated over 39 years) and depreciation with a cost segregation study ($2,000,000 depreciated over different lives) and multiplying the difference by the effective tax rate on an annual basis.         

The tax court considered six factors to determine whether assets were inherently permanent and thus not considered personal property.  In preparing a cost segregation study these factors will help distinguish personal property from the commerical building.  A personal inspection of the building, a review of blueprints, an engineering report and the allocation of costs based on contractors invoices are all necessary steps in a cost segregation study.

The potential for saving money on a net present value basis can be applied to almost any building.  It may also be possible to do a cost segregation study on a building placed in service in prior years. If you own a building or are currently constructing, expanding or purchasing a building, a cost segregation study may benefit you.

Please contact me at 203-756-7426 to discuss how a cost segregation study can benefit you.
 
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