Cost Segregation Report
This is a complete guide to Cost Segregation in 2020.
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More depreciation expenses.
More return on your investment.
More interest free money.
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Since 1997, increasing numbers of commercial building owners and residential owners have cut their current income taxes by using Cost Segregation. With Cost Segregation, a shopping center owner recently changed 30% of their property cost from 39-year depreciable to 5, 7, and 15-year depreciation. Accelerating this depreciation reduced federal taxes for ten years!
A Cost Segregation Study (CSS) is a systematic engineering-based analysis of expenditures for a new building, a renovated property, or an existing structure. A CSS separates the cost of a building into classifications allowing the most rapid legally permitted depreciation. In 1997, the Tax Court ruled that many parts of a building can be depreciated sooner than a 39-27.5 year straight line. For example, certain electrical can be depreciated in 5-years and vinyl wall covering in 7-years. Site improvements are depreciated over 15-years. Hundreds of building components can have depreciation accelerated. Cost Segregation finds them for you. A cost segregation study covers residential and commercial properties.
Why do Cost Segregation?
The greatest benefit is the fastest legal permissible depreciation, immediately reducing taxable income. In a 35% bracket, every dollar of depreciation cuts taxes by 35 cents. Tax cuts can continue up to fifteen years. Another benefit is that cost segregation costs out many components of a building so that, if that component must be replaced, it can possibly be made an abandonment loss, reducing the basis, and changing more of the “gain at sale” from short term to long term.
How does Cost Segregation work?
The best Cost Segregation method is identified by the IRS as the engineering approach. An expert analyzes the building(s) in person. He itemizes the components in the building and determines how much each represents as a share of the property cost. Then, the components are assigned to the correct depreciation terms. The consultant writes up the findings with an executive summary, a detailed report, depreciation assignments, and other documentation required by the IRS. Residential properties require less work.
What will Cost Segregation do for your building(s)?
The exact results depend on the details, but, as an example, for an office building worth $3 million, cost segregation will cut federal taxes by $150,000 in the first five years. If there is state tax, the tax cut will be even bigger. The return on investment is typically 1,000% to 3,000%, although we’ve seen ROI’s up to 8,500%. Cost Segregation yields first year tax reductions between eight to ten times its costs.
What items are included in commercial properties?
It depends. Each industry is different since different components are specific to the industry. Here are some general examples.
Land Improvements – 15 year property: • Site preparation • Site utilities • Asphalt paving • Concrete curbing • Exterior lighting • Fencing • Railings • Flagpoles
Furniture, Fixtures and Equipment – 7 year property: • Carpeting • Vinyl flooring • Wallpaper • Interior fencing • Decorative millwork • Dock equipment • Fire extinguishers • Decorative lighting • Equipment • Guard rails
Distributive Trades and Services – 5 year property: • Observation windows • Pass-thru windows • Cabinets • Data wiring • Equipment wiring • Filing systems • Supplemental power supply • Supplemental HVAC
Can Cost Segregation cause an audit?
It’s highly unlikely. Thousands of Studies are done every year. IRS personnel have verified Cost Segregation is not an audit “flag”. Also, every depreciation schedule that we issue is based on current tax law, so there is very low risk. Lastly, we will defend our work at no cost.
Why hasn’t my accountant mentioned Cost Segregation?
Cost Segregation is typically not a specialty of CPA’s, since it requires knowledge of structural engineering and construction costs. If your CPA has not mentioned Cost Segregation, that doesn’t mean he does not approve of it. We work with many CPA’s.
How long does Cost Segregation take? What is involved?
We complete your report within 2-14 days. Just supply the plans, your cost basis, and current depreciation schedule(s). Cost Segregation requires no time from you or your employees.
Does Cost Segregation work for buildings already owned?
Cost Segregation helps with nearly any commercial building prior to the fifteenth year of ownership. For buildings that have been owned for a while, we do “Look Back” Cost Segregation, whereby you recover all prior depreciation you missed from prior years in a onetime adjustment. Often, this adjustment is very substantial.
If we do a renovation, is there any value to Cost Segregation?
Yes. Cost Segregation offers a huge benefit because it allows a current year loss for the value of the property that is torn out. That same tax loss ends up being a reduction in the cost basis of the property, thus converting more of the profit at the time of sale to a long term capital gain.
How can Cost Segregation yield “tax savings” when it doesn’t increase total depreciation?
Cost Segregation changes when depreciation can be used. It enables accelerating depreciation into the first fifteen years of building ownership, which cuts taxes, as well. While it’s true that depreciation equals the cost of the property and no more, by getting the depreciation based tax reductions so much sooner, the property owner gets new cash for up to fifteen years, almost like an interest-free loan. If the building owner invests that extra cash, the compounded growth of the money (at just 5%) will pay all extra taxes in the later years (when depreciation is lower) and build a substantial balance of extra cash.
Can Cost Segregation Help the Unprofitable Business?
We say “Probably!”. First let’s look at how Cost Segregation helps property owners. Cost Segregation speeds up depreciation to cut payable taxes now. Standard commercial building depreciation is 39-year straight line and Cost Segregation allows reclassification of up to 50% of a building into either 5-, 7- or 15-year depreciation. This means Cost Segregation can increase first year depreciation up to ten times. This big increase in depreciation really cuts taxes. For example, with federal tax @ 35% and state @ 5%, the tax reduction is $40,000 for every $100,000 of extra depreciation.
Most cost segregation studies happen a few years after the building is put in use, so we usually apply changes in depreciation from prior years as a one-time adjustment using an IRS 3115 “change in accounting method” form. However, this does not help a business with any current profits! It is true that, in the following years, the “stockpile” of depreciation will eliminate income taxes when the business becomes profitable, but this is a delayed upside and it is not the great benefit situation that usually accompanies Cost Segregation.
But there is a silver lining: Cost Segregation can also be used to reduce taxes from prior years.
It’s a fact. Cost segregation can be used to amend returns going back up to four years.
For example, if a business made profits in the prior four years, then taxes for those years are eligible for refund if returns are amended.
A typical $2,000,000 building yields a tax cut of $50,000 in the first year with cost segregation, versus $20,000 with straight-line, a $30,000 upside. The second year upside would be $25,000 and for year number three, it should be about $21,000, which totals a $76,000 tax refund from those profitable years.
Thus, if a business needs extra working capital or cash for additional inventory, cost segregation can deliver a substantial tax refund from prior years, even if current business conditions are less profitable.
Nearly every building can help reduce payable income taxes.
The Six Types of Cost Segregation Studies.
The IRS describes six different Cost Segregation methods on its website. They are:
1. Detailed Engineering Approach from Actual Cost Records: Plan documents, actual cost information, and an onsite inspection meld into a report that takes actual costs for items and services and imputes “soft” costs to arrive at “as built” costs for all components of the building. This report is highly regarded and thorough. It strongly substantiates the cost distribution to the various macrs depreciation terms. This is one of the two most defensible cost segregation methods and is the one that is used second most frequently by Emunah Cost Segregation.
2. Detailed Engineering Approach based on Cost Estimation: In this method, the property cost is allocated to its components, based on “reverse engineering” whereby the building is costed as if it was being built new today and a pro rata percentage contribution is calculated for the various components. Lastly the actual cost of the building is allocated to the individual components, based on the calculated percentages. This is the other very robust and highly defensible cost segregation method. This is the method we use most frequently. Click here for a free estimate of cost segregation for your building.
3. Survey Letter Approach: Providers to the original construction supply letters of cost verification. The sum of these amounts should theoretically allocate the property cost to components, although every contributor must respond and everyone’s response must be HIGHLY DETAILED, the odds of which are very low. We do not use this approach.
4. Residual Estimation Approach: This approach is most like a real estate appraisal, in which certain component categories are estimated (like the aggregate dollar amounts applicable to 5-, 7-, and 15-year), with the leftovers dropping into 39-year straight line. This is not highly documented and relies heavily on the credibility of the party rendering opinions of value. We do not use this approach.
5. Modelling-Sampling Approach: If a building type is repeated (restaurant chain, franchise), the modelling approach is valid. A first study is done to be used as a template for all others, with minor adjustments for each site. The Sampling approach, takes a representative group of studies out of a large number of identical buildings and computes a composite depreciation template to apply to all properties. The Modelling and Sampling approaches substantially reduce the Cost Segregation cost per building. These are methods that we use at Emunah Cost Segregation
6. Rule of Thumb: The short definition of this is ”winging it”. How it works is you allocate depreciation for your property as you see fit. Since reasonably priced cost segregation by reputable consultants yields returns on investment up to 8,000%, we do not recommend Rule of Thumb.
Temporary is Better!
When you construct your next building, remember that temporary is better. While it sounds counterintuitive, it is true that Cost Segregation will do you the most good if you choose a temporary way to attach things to your building. Why? Because a component of a building that is attached with a non-permanent adhesive or a detachable mechanical apparatus, is often allowed, under the tax code, to be treated as rapidly depreciable personal property, qualifying for 5-, or 7-year depreciation, versus 39-year, if is permanently attached. And, the further benefit is that 5- and 7-year property can be accelerated even faster by the use of double declining balance depreciation, resulting in first year total depreciation that we have seen as high as ten times the prior 39-year straight line. Before you worry that this means components of your building will start falling off, rest assured that the temporary adhesives are all strong enough to hold up for the life of the component. The key difference is that that, when it is time to remove the asset, you can more easily remove it, often with minimal damage to the attaching surface. This also saves money on installation of the replacement surface.
What are some ways that you can apply this financially lucrative concept to your next building? Here are a few:
Vinyl flooring can be temporarily attached (with “strippable” adhesive). The “strippable” adhesive allows flooring to be depreciated in five years versus thirty-nine.
Ditto for removable adhesive for vinyl wall coverings
There are now wallpapers that are identified as “temporary”.
Carpeting can also be glued down with permanent or temporary adhesive or tacking.
Cabinets should be built with all sides enclosed. They should not have open backs, where the wall of the building performs as the back enclosure of the cabinet. The back enclosure should be of a substantial material so as to match the strength of the other cabinet surfaces. When installed, the cabinet should not be glued to the wall or floor. It should also not be nailed in place – it should be attached only with removable screws. It should also be placed on top of flooring. Flooring should not be installed so as to treat the baseboard of a floor standing cabinet as a boundary of the flooring installation.
Electrical circuit designs should, when at all possible, isolate service to equipment that is clearly specific to the business occupying the building and not part of the general building electrical service. For example, in a dentist’s office, the electricity powering an exam chair, the drilling equipment, x-ray modules, and exam room computer system(s) should be installed and identified as specific to such equipment so as to enable rapid depreciation.
Non-standard plumbing installed to specifically service an installation of equipment for medical or manufacturing purposes should be identified. Plumbing lines that are “home runs” are clearly the easiest to identify, whereas plumbing that junctions other lines will be more difficult to isolate and cost individually.
If a building makes extensive use of “mood” lighting or lighting that is essentially a décor item, versus an item that is strictly utilitarian, the only way these expensive and extensive lighting décor items are allowed to be accelerated is if the building has a secondary, more basic, lighting system installed that is capable of illuminating the interior such that work could be done with only that lighting functioning. Thus, the décor lighting could be termed as temporary, since its removal would not render the building devoid of light. In this case, then, the circuitry powering the décor lighting would also be treated a rapidly depreciable property.
These are just a few examples of things you can consider when building to make the depreciation law work in your favour. If we are involved at the beginning of the construction project, we will suggest all possible favourable changes to be made to optimize the use of Cost Segregation. Generally speaking, it always better to think “temporary” when you install anything in your building. The more temporary the asset is, the greater the potential for it be able to be rapidly depreciated. We will generally touch on this area of opportunity when we create the free no obligation estimate of cost segregation for your construction project. Just click on the link, fill in the form, and we will send you the best cost segregation estimate in the business.
How Much Does a Cost Segregation Study Cost?
It all depends on property type, year purchased, documents available, etc. The tax savings will always be exponentially greater than any fee.
Typically, a residential cost segregation report costs $500 and a commercial cost segregation report costs $1,500.
Residential: Use the form located HERE to place your order.
Residential: Use the form located HERE to place your order.
How Do I get Started?
Bonus Depreciation & Cost Segregation?
Your tax savings are even greater with bonus depreciation and cost segregation. Depending on the date the property was placed in service, you can use 30%, 50%, or 100% bonus depreciation on your cost segregation report. This is in addition to the reclassification of assets.
What is Asset Disposition?
The savings are even greater for your cost segregation report. Simply use asset disposition calculations.
When there is a partial asset disposition, there are removal costs associated with that disposition. The final Tangible Property Regulations include favorable provisions regarding the treatment of removal costs. If a taxpayer disposes of an asset, including a partial asset disposition, and takes into account the adjusted basis of the asset or component of the asset in realizing gain or loss from the disposition, the costs to remove that asset can also be deducted. Cost segregation studies can determine the adjusted basis of components removed during a renovation or remodeling. If the renovation or improvements to the asset are required to be capitalized, a partial asset disposition election can be made, allowing for a loss on the disposition and a deduction of the removal costs. Knowing the basis of the components removed will facilitate this tax treatment.
Does Depreciation Recapture Apply?
Perhaps! Depending on many factors. However, here are some legal ways around it:
Partial asset disposition
Property valuation at time of sale
Repair instead of capitalization
1031 like kind exchange
These are advanced real estate tax strategies that need to be discussed more in depth.
What is 1245 Property?
Section 1245 property defined by the IRS.
Section 1245 property includes any property that is or has been subject to an allowance for depreciation or amortization and that is any of the following types of property.
Personal property (either tangible or intangible).
Other tangible property (except buildings and their structural components) used as any of the following. See Buildings and structural components below.
An integral part of manufacturing, production, or extraction, or of furnishing transportation, communications, electricity, gas, water, or sewage disposal services.
A research facility in any of the activities in (a).
A facility in any of the activities in (a) for the bulk storage of fungible commodities (discussed later).
Where applicable, that part of real property (not included in (2)) with an adjusted basis reduced by (but not limited to) the following.
Amortization of certified pollution control facilities.
The section 179 expense deduction.
Deduction for qualified clean-fuel vehicles and certain refueling property (as in effect before repeal by Public Law 113-295).
Deduction for capital costs incurred in complying with Environmental Protection Agency sulfur regulations.
Deduction for certain qualified refinery property.
Any applicable deduction for qualified energy efficient commercial building property. See section 179D.
Amortization of railroad grading and tunnel bores, if in effect before the repeal by the Revenue Reconciliation Act of 1990. (Repealed by Public Law 99-514, Tax Reform Act of 1986, section 242(a).)
Certain expenditures for child care facilities if in effect before repeal by the Omnibus Budget Reconciliation Act of 1990, Public Law 101-508, section 11801(a)(13) (except with regards to deductions made prior to November 5, 1990).
Expenditures to remove architectural and transportation barriers to the handicapped and elderly.
Deduction for qualified tertiary injectant expenses.
Certain reforestation expenditures.
Deduction for election to expense qualified advanced mine safety equipment property.
Any deduction for qualified film, television, or live theatrical productions allowed under IRC section 181.
Single purpose agricultural (livestock) or horticultural structures.
Storage facilities (except buildings and their structural components) used in distributing petroleum or any primary product of petroleum.
Any railroad grading or tunnel bore.
What is 1250 Property?
Section 1250 property defined by the IRS.
This includes all real property that is subject to an allowance for depreciation and that is not and never has been section 1245 property. It includes a leasehold of land or section 1250 property subject to an allowance for depreciation. A fee simple interest in land is not included because it is not depreciable.
If your section 1250 property becomes section 1245 property because you change its use, you can never again treat it as section 1250 property.
What is Passive Activity Loss?
IRS Definition of passive activity loss. Generally, your passive activity loss for the tax year is the excess of your passive activity deductions over your passive activity gross income. For a closely held corporation, the passive activity loss is the excess of passive activity deductions over the sum of passive activity gross income and net active income.
In cost segregation we deal with passive activity losses.
What is Passive Activity Loss Limitation?
If you actively participated in a passive rental real estate activity, you may be able to deduct up to $25,000 of loss from the activity from your nonpassive income. This special allowance is an exception to the general rule disallowing losses in excess of income from passive activities. Subject to income limitations.