Cost Segregation.

To skeptics, that would sound too good to be true. Yet some CPA firms provide a service that can help clients to return as much as one dollar in tax savings for every ten cents spent on the service. This service, known as cost segregation, brings significant tax savings, recognized by the Internal Revenue Service (IRS), to building owners interested in retaining cash. (The Practicing CPA) 

What is cost segregation?

Cost Segregation is a tax savings tool allowing businesses and individuals to increase cash flow by accelerating deductions and deferring federal and state income taxes. This method includes restructuring the depreciation of commercial properties based upon a shift of certain assets from 39 year depreciable real property to 5,7, and 15 year depreciable property. Most commercial real estate property purchased, constructed, renovated, or expanded since 1987 may qualify for accelerated depreciation deductions?

For changes to prior year’s depreciation, NO amended returns are needed.

In 1997 a landmark tax court decision upheld the application of cost segregation as viable. The Hospital Corporation of America case is the seminal case for cost segregation studies and the IRS has agreed that a taxpayer can use a cost segregation study to segregate building costs. Consequently, Congress and the IRS have responded with various laws and rulings, expanding further the complex body.

A third party study performed by an objective, independent and qualified professional will withstand IRS scrutiny. It can also correct previous misclassified assets and allow the taxpayer to claim a catch up adjustment for the differences. Study results may be used to reduce real estate taxes too.

Cost segregation studies should be performed by consulting firms with expertise in engineering, construction, tax and accounting. The IRS’s underlying assumption in determining what constitutes a quality study is that the study is performed by a “person competent in the design, construction, auditing and estimating procedures related to building construction”.

Cost segregation is a very specialized and complex area. As such, most CPA’s offering traditional services refer or outsource these projects to specialist firms. Expertise in cost segregation requires much more than an understanding of accounting and tax law.

Doesn't my CPA already do cost segregation for me?

Probably not, because CPAs simply do not have the engineering expertise necessary to properly break-out all the assets (costs) that are considered in a cost segregation study.

How does cost segregation work?

A comprehensive and appropriately documented cost segregation analysis maximizes a building’s tax benefits by identifying, classifiying, and segregating a much larger percentage of a building’s assets for accelerated depreciation for federal income tax purposes. This can mean three, five, sometimes twenty times more savings than the 3% found in cabinets and carpeting. A cost-segregation specialist looks for many items when working to identify tax savings in a building. Questions that a specialist would ask include:

  • Is there more than one power source in your office?
  • Do the walls in your office penetrate the ceiling tiles, and are they load bearing?
  • Is the decorative paneling in your reception area and conference room glued, nailed, or hung on the wall?
  • Is your cooling system oversized in order to cool your data processing room?

(The Practicing CPA)

What does an approved cost segregation study consist of ?

  • Certification by the study’s author
  • Qualifications of the personnel performing the study
  • Project overview and subject property description
  • Scope of the study
  • Methodology and procedures
  • Asset classification summary
  • References and citations to tax court cases, revenue rulings and regulations justifying asset classification
  • A detailed “take-off” spreadsheet showing property components and costs
  • Reconciliation of project cost to depreciation schedules
  • Calculation of adjustment for property acquired and depreciated in prior tax reporting years
  • Photographs of the subject property

Legal history

Under prior law taxpayers would separate a building’s parts into it’s various components; doors, walls, and floors. Once these components were isolated, taxpayers would depreciate them using a short cost-recovery period. CPAs referred to this practice as component depreciation.

The introduction of the accelerated recovery system (ACRS) and the modified accelerated cost recovery system (MACRS) eliminated the use of component depreciation, but not the use of cost segregation.  Hospital Corporation of American V. Commissioner, 109 TC 21 (1997), is the seminal cost segregation case. In it the Tax Court permitted HCA to use cost segregation with respect to to a multitude of improvements. Critical to the Tax Courts analysis was that in formulating accelerated depression methods, Congress intended to distinguish between components that constitute IRC section 1250 class property (real property) and property items that constitute section 1245 class property (tangible property). This distinction opened the doors to cost segregation.

Information for CPA's

A retroactive study can be performed for properties that have been capitalized as far back as 1087. You can claim the difference between the allowed depreciation and what you actually claimed in prior years, all on the tax return.

  • No amended returns or IRS approval
  • Depreciation “Catch-up” is all claimed in current tax year
  • Form 3115 filed with current tax return
  • The 481(a) adjustment is captured on form 4562 on the current tax return

When a taxpayer performs a retro-active cost segregation study, the differences in depreciation deductions for the prior years are accounted for via a catch-up deduction in the current tax year. This is reported on the tax payer’s return as a section 481 adjustment. Under Rev Proc 2012-19 the adjustment is taken entirely in the current year and does not necessitate the filing of amended returns. The 481 adjustment is automatically accepted by properly completing and attaching Form 3115 to the taxpayer’s return. Information necessary to complete Form 3115 will be contained in the Cost Segregation Study report if it is prepared by a qualified firm and meets the IRS’ requirements for a “quality” study.

Opportunities for CPA's

Cost Segregation Opportunities for CPA’s, Accountants, Real Estate Attorneys, Tax Attorneys and Consultants

Cost segregations can provide significant benefits to your clients including increased cash flow, accelerated tax deductions, and improved returns on their real estate investments. We work in partnership with professional advisors and consultants to bring this service to their clients. You identify clients that are good candidates for a cost segregation study and we will provide a free estimated analysis of benefits to consider for a final decision.

What is the key to maximizing depreciation benefit?

The key to maximizing the depreciation benefit is to apply a combination of in-depth tax depreciation knowledge with a detailed engineering approach. This involves a familiarity with pertinent court cases, revenue rulings and other pronouncements, and a detailed blueprint analysis in order to identify, quantify and establish an income-tax basis for the shorter lived property in residential buildings.

  • Is there more than one power source in your office?
  • Do the walls in your office penetrate the ceiling tiles, and are they load bearing?
  • Is the decorative paneling in your reception area and conference room glued, nailed, or hung on the wall?
  • Is your cooling system oversized in order to cool your data processing room?

(The Practicing CPA)

How can cost segregation can reduce your insurance?

Once a Cost Segregation study has been completed and each component of the property has been isolated and properly valued, the argument can be established to reduce the valuations by the amount of the items that would not be damaged by a loss or might otherwise be excluded.  Examples of such items could be the parking lot, landscaping, slab and underground improvements. Finding insurance companies and brokers with such “appetites” is not always easy or possible but our exclusive Certified Insurance Councilors stay abreast of the ever-changing markets and offer their advice FREE of charge and obligation.

Who are we?

Legacy Ventures, L.L.C. is an authorized A.C.R.S independent representative in Texas and Oklahoma.

A.C.R.S. are CPA’s, engineers, consultants and tax professionals with over 100 years of combined experience.Our studies meet the highest standard of quality in the cost segregation industry. We stand behind our work with guaranteed support in the event of an IRS examination.

What Our Clients Say

Frequently Asked Questions

The average study will allocate, or reallocate in the case of a look-back study, anywhere from 20-35% of the depreciable cost basis to a shorter life. For every $100,000 moved from 39-year to 5-year, the 10-year net present value savings is approximately $26,000 (based on a 40% tax rate and a 8% discount rate).

Studies performed in the first year property is placed in service do not generate any higher risk. However, retroactive studies are slightly more susceptible to audit, because they require the filing of a form 3115 that is reviewed by a special unit within the IRS. The risk is generally very low and can be mitigated by using a reputable, qualified firm to perform the study.

Yes. The Internal Revenue Service recognizes properly prepared cost segregations as a valid tax benefit. And current IRS procedures allow a taxpayer to relect the tax benefits on a current return without amending prior years returns.

Look-back studies can be performed on properties placed in service as far back as January 1, 1987. Of course, it may not make sense to perform a study on a property that was placed in service 20 years ago, but the facts and circumstances will ultimately be the deciding factors.

Probably not, because CPAs simply do not have the engineering expertise necessary to properly break-out all the assets (costs) that are considered in a cost segregation study.

When a property is sold, a gain or loss will be recognized. Property classified as real property will be taxed at capital gains rates, while personal property will be taxed at ordinary rates. When a cost segregation study is performed, items that would normally be considered real property are instead allocated to personal property. The ordinary income rate can be higher or lower than the capital gain rate, depending on the situation.

Circumstances vary, but generally studies are beneficial in situations where building costs are at least $500,000 and the owner intends to hold the property for at least five years.

Yes. First year’s tax savings usually exceed the cost of the study and the fees are tax deductible.

No. It just allows businesses to accelerate a portion instead of taking it equally over a longer period of time. This increases cash flow in the earlier years of property ownership via reduced taxes.

Acquisitions or new construction projects may benefit as well as buildings constructed or purchased years ago.

Types of property that often benefit from a cost segregation study include:

  • Apartments
  • Automobile Dealerships
  • Banks
  • Grocery Stores
  • Hotels/ Motels
  • Manufacturing Facilities& Plants
  • Medical Centers
  • Office Buildings
  • Restaurants
  • Retail Stores
  • Senior Living Facilities
  • Warehouses

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