Additional guidance supported by the IRS to assist the taxpayer in categorizing the depreciable lives of assets correctly is in the form of court cases and revenue rulings. These court cases and revenue rulings are highly subject to interpretation. Our experience has shown that the IRS itself is not consistent in their interpretations of the court cases, revenue rulings and the tax depreciation laws. Unfortunately tax laws are not as clear as we would like; but, what is clear is how the IRS expects the Cost Segregation Study to be performed. The IRS has made it known for years that performing Cost Segregation Studies using the "residual method" or taking percentages via the "invoice approach" are not methodologies that will stand up under audit. The IRS has said in a recent "Legal Memorandum 199921045" the Cost Segregation Study must be performed using the "Engineering Approach" . The best engineering approach study provides the most accurate classification of all the assets into the correct asset categories. The end results of a properly performed engineering approach study include a fully supportable study both from a tax and construction standpoint; also, the proper classification of assets under MACRS which provides the correct depreciation recovery period and method of recovery.
Anyone familiar with business finance knows the benefit of accelerated depreciation deductions, because of the time value of money. Owners of real estate, if given the opportunity, would choose to take the deduction today rather than waiting to receive it over 39 years. It is well known that a business depends on its cash flow today to generate tomorrow's profits; you cannot afford to wait 39 years for the depreciation deduction earned today! The results of a properly performed Cost Segregation Study show that for every $1,000,000 of real property reclassified from a 39 year to a 5 year category, approximately $220,000 is generated as a net present value tax benefit. (see Frequently Asked Questions: What Kind of Real Esate Qualify?)
Our Cost Segregation Studies focus on the use of the engineering approach and the appropriate documentation. Our cost segregation specialists perform an extremely detailed analysis of the construction blueprints and cost information. This is followed up with an on site inspection to verify the information supplied and to confirm our findings. In the case of an acquired property, we conduct a detailed site inspection, then use IRS industry standard construction cost reference sources to reverse engineer the construction costs. These costs include indirect and soft costs such as general conditions, professional fees, permits, etc. For example: if your building has special equipment with costs known to belong in the shorter life category you would classify the asset and move on. Here is where questions arise, such as: (a) what parts of the building plumbing, HVAC or electrical systems costs also belong in the shorter life category? (b) Are these systems used directly and primarily for that special equipment? Our report will tell you the costs of all the support systems components. This would include every foot of supply and waste piping, fixtures, every pound of supply and exhaust ductwork for the HVAC system; every foot of conduit, wire and circuit breakers; plus the portion of the electric panel for that special equipment traced all the way back to the switchgear.
American Dream Appraisal professionals have extensive experience and knowledge of construction methods, engineering, and the Internal Revenue Code. The latter includes the applicable Tax Court Cases and Revenue Rulings. Our work paper documentation is thorough and detailed, providing you with complete documentation, also know as an audit trail in the event of an IRS audit.
We are the best professionals to bridge the gap between your accountant and the construction or acquisition team. Your business can increase cash flow with a Cost Segregation Study.
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Frequently Asked Questions
What is Cost Segregation?
How to Uncover Hidden Cash Flow using a Cost Segregation Study?
What kind of real estate qualifies?
What's the Engineering Approach to your Segregation Study?
Who can conduct a Cost Segregation Study?
What is Cost Segregation?
Cost Segregation is a strategic tax savings technique designed by the IRS to allow companies and individuals, who have constructed, purchased, expanded, or remodeled any kind of real estate to increase cash flow by accelerating depreciation deductions and deferring federal and state income taxes.
Beyond identifying furniture, fixtures, and equipment (FF&E) that are depreciated over 5 or 7 years for tax purposes, Cost Segregation Study dissect construction costs that are usually depreciated over 27 ½ or 39 years. A Cost Segregation Study identifies all construction-related costs that can be depreciated over 5, 7 and 15 years. Often, 20% to 60% of the total electrical costs in most buildings qualify as personal property which is depreciated over 5 or 7 years instead of 27 ½ or 39 years. This reduced tax lives results in accelerated depreciation deductions, a reduced tax liability, and increased cash flow.
What are the benefits of a Cost Segregation Study?
- Immediate increase in cash flow through accelerated depreciation deductions.
- Reduce income taxes and real estate property taxes.
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Opportunity to claim ‘catch up’ depreciation on previously misclassified assets. - Independent third-party analysis proven to withstand IRS review.
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How to Uncover Hidden Cash Flow using a Cost Segregation Study? Our Engineering approach to your cost segregation study carefully breaks down your construction or acquisition costs (used real estate) 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.
Why not recover at least 5 cents (and often 8 to 10 cents) for every dollar you spend on new construction or a purchased building? We can provide that cash payback via accelerated tax depreciation by segregating building costs into shorter lived personal property and site improvements.
Critical to establishing this significant cash benefit is our detailed engineering analysis. We provide complete cost analysis and supporting documentation, as well as the experience gained from numerous, successful IRS audits. Our engineers understand accounting and tax codes. They perform quantity take-offs from construction drawings or available data for purchased buildings. The key to withstanding IRS scrutiny is thorough our 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.
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What kind of real estate qualifies?
Candidates for cost segregation services include buildings that were constructed since 1986, acquired since 1986, or need catch-up depreciation. Any structure used for business or as rental property, is eligible for Cost Segregation benefits. The table below represents the percentages of project-related construction costs that can be reclassified from 27.5 or 39-year real property to 5, 7, or 15-year property.
|
Warehouses |
9-16% |
|
Offices |
11-24% |
|
Apartments |
19-29% |
|
Retail Stores |
14-31% |
|
Auto Dearlerships |
19-34% |
|
Hotels |
24-34% |
|
Grocery Stores |
26-36% |
|
Restaurants |
22-39% |
|
Banks |
24-43% |
|
Medical Facilities |
24-42% |
|
Golf Courses |
34-49% |
|
Manufacturing Facilities |
29-59% |
Other benefiting Cost Segregation projects include shopping malls, airports, sports facilities, driving ranges, resorts, health care facilities, industrial buildings, auto service centers and more.
Leasehold improvements can be even more beneficial because these interior build-outs generally produce a proportionally higher ratio of qualifying property.
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What's the Engineering Approach to Cost Segregation?
The engineering approach to completing your cost-segregation study involves identifying and segregating construction costs related to 5-, 7-, and 15-year property from the 27.5 and 39-year non-residential property costs. The engineering approach to completing your cost-segregation study includes:
- Review and examine project architectural and engineering drawings and specifications to identify all building construction assets and its component parts, the building services systems, and interior finishes and personal property that qualify for accelerated depreciation.
- Obtain and review copies of approved contractor pay requests, change orders, and miscellaneous invoices in order to segregate these costs properly into the correct asset classifications for federal income tax purposes.
- Develop and provide a listing of construction cost for which a specific breakdown is required from the contractors involved. An analysis of all cost data, including the general contractors' application for payment, change orders, owner-incurred costs. If the contractors are not able to provide this information, we will estimate those costs of the assets by using nationally recognized cost estimating manuals.
- Visit the facility for a physical inspection of the property to ensure that all qualifying personal property and land improvement assets have been identified.
- The identification and preparation of an itemized list of those property units that, in our opinion do and do not qualify for shorter life, based on our experience with the Internal Revenue Service and interpretations of revenue rulings, private letter rulings, and judicial decisions.
- Allocate project indirect costs, such as contractors' general conditions, architectural/engineering fees, permits, etc., to all project-related assets on a functional basis.
- A proper reconciliation of the total cost used in our analysis to the total project capitalized costs, as documented in your accounting and control records.
- Prepare a written report which includes project background information, methodology, fixed asset classifications and descriptions, allocation of project related fees and services, fixed asset classification spreadsheets segregating the assets into personal property (5 or 7 year tax life), land improvement property (15 year tax life), and residential real or commercial property (5 or 7 year tax life). Also, includes references to court cases, revenue rulings, tax citations and photographs supporting the position taken regarding the identification of personal property and land improvement assets for federal income tax purposes.
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Who can conduct a Cost Segregation Study?
To ensure that you obtain the optimum tax savings allowable by law, American Dream Appraisal provides you with the following expertise:
- Engineering, construction, and tax experts that can accurately identify and classify and evaluate assets to appropriate categories.
- Knowledgeable staff of changing tax laws that ensure taxpayers maximize savings with proper application of IRS Cost Segregation guidelines.
- Knowledgeable staff of prior court cases and rulings pertaining to individual assets to identify what really is personal property.
- Knowledgeable staff that can exceed the criteria within the IRS Audit Techniques Guide to ensure an accurate study that will withstands an IRS audit.
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American Dream Appraisal
nuno@americandreamappraisal.com
phone: 925-437-2090
Fax: 925-219-4025
