Certified Public Accountant Updates
What is Cost Segregation?
Cost Segregation is the detailed separation of building components and assets by allowable useful life for Federal Income Tax purposes in order to capture the dividend and/or cash flow benefits with shorter depreciable lives. While the capturing of only the carpet and cabinets as personal property may yield 3% of the component costs, a non-intrusive yet detailed engineering study can mean three-, five sometimes 20 times more savings than the 3% found in cabinets and carpeting. These savings can be substantial and the cost of the report can be paid for in the first year of savings!
Why do a CostSegPlus™?
Because of the “present value effect” — AKA a “dollar today is worth more than a dollar tomorrow” — an IRS-compliant tax deduction today is worth far more than one claimed in the future. Assume that the deduction is for depreciation and that the “today” is actually a 5 or 7 year recovery period while the “tomorrow” is a 39 year recovery. The accelerated depreciation from the shorter period means increased current cash flow, which in turn can be used to underwrite current or future expansion. The real dollar savings go to your bottom line! And the CostSegPLus ™ unconditional guarantee makes this an irresistible proposition.
What About Aquired Property?
For purchased property, one key is the cost/value allocated to land versus land improvements, building, and personal property. The most defensible position for the taxpayer is a complete property appraisal. Another approach is to determine the market value of the land only. The balance of purchase price can be assigned to the improvements. The least costly alternative, and the one most likely to be scrutinized by the IRS, is to base the allocation on the assessor’s split between land and real property improvements.
How Does Cost Segregation Affect A Contractor or Management Company?
These types of companies can offer Cost Segregation as a value added service. Gerber & Co. can counsel you on specific procedures to observe during construction that can document allocations and save significant time and money.
What potential tax savings may be lost by neglecting to take advantage of accelerated depreciation?
Accelerated depreciation adheres to well found interpretations of the Internal Revenue Code sections, applicable court cases and revenue rulings. Under IRS Revenue Procedure 96-31, real estate owners can change their method of accounting in order to re-compute the allowable depreciation and claim a retroactive adjustment for previously filed tax returns for both open and closed tax years. This creates an opportunity to correctly classify fixed assets and claim the entire difference between the allowable depreciation and the depreciation actually taken on past tax returns. Through four equal annual adjustments, real estate owners can correct what may have been years of incorrect property depreciation write offs and realize large tax savings.
How do I get started?
The initial feasibility report is a free, simple one-page form. Upon completion by the owner, fax or email to us. An initial free evaluation will be made available to the owner showing costs and a likely range of savings using the Cost Segregation Program. We will also provide a copy of our written unconditional guarantee.
If an agreement is made to go forward, the cost segregation agreement will allow our engineers to perform an engineering study identifying and classifying building components other than carpeting and cabinets. Component analyses will include walls flooring, and ceilings, plumbing, electrical, heating and air-conditioning, sound system and lighting.
Can I speak with an expert now?
Sure! Call 310-289.9888 and speak with Selwyn Gerber CPA or Suzanne Payne CPA who will take you through the intial steps and give you a preliminary indication of whether your property is likely to qualify for the substantial tax cuts we generally deliver.
We can typically assist in recovering at 10 cents or more for every dollar you spend on new construction or a purchased building using IRS-compliant accelerated tax depreciation.
A cost segregation study carefully breaks down your construction or acquisition costs and allocates them to specific categories – maximizing accelerated depreciation for qualifying personal property. The shorter the depreciation period, the greater your tax savings. This study could also be used to provide the basis for your property records system. In addition, certain construction costs do not add to value and should be excluded from the property tax basis. These may involve overtime, demolition, etc.
Although the optimal time to begin a cost segregation study is when plans to build, remodel, or expand a building are first drafted, eligibility extends to:
· Buildings and facilities that have been newly constructed since 1987.
· Buildings and facilities constructed before 1986, but acquired in a taxable transaction after 1986.
· Building renovations and additions completed after 1986.
The first step is the segregation of the project costs into specific asset groups. The costs to be segregated include the actual direct costs of construction or acquisition and the indirect or “soft costs” (i.e. legal, architectural, engineering fees, appraisals, construction management, etc.) The second step is categorizing the assets based on the appropriate depreciable lives for income tax purposes.
By identifying, segregating, and reclassifying costs related to 5, 7, 15, and 20 year property from the 27.5 or 39 real property categories, such property can be depreciated over a much shorter time frame. In addition, the 5, 7, 10, 15, and 20 year property classes are depreciated using accelerated methods, which further increase the deductions in early years.
Critical to establishing this significant cash benefit is a detailed engineering analysis. We provide complete cost analysis and supporting documentation. Our engineers understand accounting and tax codes as well. They perform quantity take-offs from construction drawings or available data for purchased buildings. The key to withstanding IRS scrutiny is a thorough application of engineering standards and our prior successful negotiations with the Treasury. We do not merely rely on broad percentage allocations or contractors lumped costs.
If you depreciate newly constructed or purchased buildings over a 39 year tax life (27.5 years for residential rental real estate), you have left cash in the building. You can recover on average of 10 cents of every dollar in the building account by accelerating tax depreciation from shorter lived personal property and site improvements.
The primary authority for this segregation of building costs is Revenue Procedure (Rev. Proc.) 87-57, 1987-2CB687, which provides comprehensive instructions and depreciation rate tables for computing depreciation available under Code Sec. 168, as amended by Act Sec. 201(a) of The Tax Reform Act of 1986. These depreciation tables are known as MACRS, Modified Accelerated Cost Recovery System.
Structural components of a building, as defined in Regulations Section 1.48-1(E)(2), include such items as walls, partitions, floors, HVAC, plumbing and plumbing fixtures, etc. and other components relating to the operation or maintenance of the building. Excluded from the definition is machinery or processing materials or foodstuffs.
In contrast to the above definition, Code Section 148-1(C) defines tangible personal property as “any tangible property except land and improvements thereto, such as buildings or other inherently permanent structures.…” Tangible property includes all costs (assets) that are necessary/accessory to the operations of the business. Examples include:
· Special purpose area (e.g. clean rooms)
· Primary and secondary electrical distribution systems where the electrical load is carried to equipment, telephone equipment, internal communications and computers
· Waste treatment systems
· Carpeting, vinyl floor coverings and accordion doors/partitions
· Signage
· Cabinetry, decorative millwork and removable vinyl wall coverings
· Decorative and security lighting
Special rules incorporated from Rev. Proc. 83-35, sections 2.02 (iii) and (iv) define Asset Guideline class 00.3, Land Improvements, as “other tangible property”. Thus, costs for site improvements should be removed from construction or acquisition costs and put into this account.
In order to claim underreported depreciation for prior years, the taxpayer may request an automatic change of accounting method. The authority for this claim is Revenue Procedure 99-49. The missed depreciation may be claimed over the four ensuing years (Section 481 adjustment). The cost segregation analysis can be used for buildings placed in service as far back as 1987, even if the year is closed for tax purposes.
Two court cases support the determination of personal property apart from structural components. The most recent is H.E. Butt Grocery Company (2000), which reinforced the claim of added depreciation based upon a cost segregation study. The second and most critical is Hospital Corporation of America v. Commissioner (1997), which provided clear evidence of what the courts consider tangible personal property versus structural components.
[...] unknown wrote an interesting post today onHere’s a quick excerptUnder IRS Revenue Procedure 96-31, real estate owners can change their method of accounting in order to re-compute the allowable depreciation and claim a retroactive adjustment for previously filed tax returns for both open and closed … [...]
[...] editor wrote an interesting post today on Certified Public Accountant UpdatesHere’s a quick excerptBecause of the “present value effect†— AKA a “dollar today is worth more than a dollar tomorrow†— an IRS-compliant tax deduction today is worth far more than one claimed in the future. Assume that the deduction is for depreciation and … [...]