A cost segregation study is used to identify and segregate costs associated with construction or renovation of a building which can be depreciated over shorter terms than the building’s life. Frequently the dollars to be carved out are substantial, the additional depreciation expense in the first few years is significant, and the tax savings can be well worth the effort. The best way to illustrate the direct financial benefits of a Cost Segregation Study is through the following case study:
A new client informed us that they had constructed an office building for $1.1 million and placed it in service in 2007. The entire $1.1 million building was being depreciated straight-line over 39 years. We immediately let them know that we could do a Cost Segregation Study on the building to reclassify some of the $1.1 million construction cost to shorter period property. We would also file Form 3115 (Change in Accounting Method Application) to change the depreciation method on the building retroactively and get an immediate “catch-up” deduction for the difference between the depreciation they should have taken and the actual depreciation taken.
The client engaged us to perform the study and prepare the Form 3115 after we gave them a free estimate of the projected tax savings that would result from the study. We worked closely with a local Charlotte construction specialist who assists us with these studies using the engineering based approach required by the IRS. He conducted a detailed walk-through site inspection of the entire building, taking notes and photographs. He later reviewed the blueprints and site surveys. He also reviewed the general contractor payment applications and project change orders.
He was able to identify costs that qualified for 5 and 7 year depreciable lives, such as cabinetry, counters, floor coverings, wall coverings, break room electrical and plumbing service and office equipment power distribution. He also identified land improvements that qualify for a 15 year depreciable life, such as paving, sidewalks, parking lot, landscaping, site lighting, fencing and sewer and drainage systems. Within 6 weeks, we were able to provide the client with a report with detailed cost estimates allocating the building value into their tax lives.
The Cost Segregation Study reclassified approximately 25% of the $1.1 million building cost to 5, 7 and 15 year depreciable lives. As a result of us performing the study, the client saved about $39,000 in taxes!
Taxpayers who own office buildings, medical facilities, shopping centers, restaurants, manufacturing facilities, warehouses and most other commercial properties can realize significant current tax savings as a result of us performing a Cost Segregation Study. Cost segregation is applicable to any building acquired or constructed after 1986 as well as any building or tenant improvements.
To request a free cost segregation analysis for your properties, contact Richard A. Blum, CPA, JD, LL.M. at Rablum@wagnernoble.com or (704) 552-0553.
