Everything You Need to Know About
Cost Segregation Studies
A Special Report from
Gerber & Co.
What Are Cost
Segregation Studies?
Cost segregation is the process of separating the
costs of tangible personal property, other tangible
property, indirect costs and land improvements from
building and improvement costs.
Why Do a Cost Segregation Study?
• Current tax law dictates utilizing depreciable lives of
39 years for commercial real estate and 27 ½ years
for residential real estate.
• A cost segregation study allows taxpayers to pull out
different components of total building cost which will
enable them to utilize much shorter depreciable lives as
follows:
• Land Improvements
• Furniture and Fixtures
• Machinery & Equipment
15 yr
7 yr
5 yr
Does the Building Need to be “New”
in Order to Justify a Study?
No. A Cost Segregation study could be performed on a
building acquired after 1986 which is when the Tax Reform
Act of 1986 changed depreciable lives on real property
If the Building Was Placed in Service in the Past,
How do You Change Prior Years’ Depreciation?
The correction of depreciation qualifies as a change in
accounting method for IRS purposes. In addition to
changing the depreciation on a go forward basis, on the
next tax return filed, you can take the deduction for prior
years in 1 year.
If It Is a New Building,
What Is the Process?
A coordination of effort with the client, the general contractor and
the architect.
• Plans and blueprints are reviewed to highlight specific
areas for considerations.
• Cost budget sheets are reviewed and
reconciled to actual amounts spent.
If It Is a New Building,
What Is the Process? (continued)
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A physical walk through of the property during construction helps document specific
items to be considered.
Cost allocation of indirect costs such as labor and general conditions.
CLIENT
CPA
GENERAL CONTRACTOR
ARCHITECT
The Hospital Corporation of America
Challenges the IRS
In this 1997 case, the Tax Court concluded:
Certain assets in the hospital facilities could be
considered personal property and depreciated over
a 5-year period
The IRS Response
to the HCA Ruling
1.
2.
Action on Decision (September 3, 1999)
“We acquiesce in this
decision….The issue as to whether the various disputed items are
structural components or tangible personal property is a factual
question.”
Memorandum (April 1, 1999) “…the use of cost segregation
studies must be specifically applied by the taxpayer.”
Different Types of Property Are
Depreciated at Different Rates
Type of Property
Commercial
Residential
Land Improvements
Tangible Personal
Depreciation Rate
39 years
27.5 years
15 years
5 or 7 years
Which Properties Are Candidates
for Cost Segregation Studies?
• Commercial properties (offices, retail, warehouses) or
apartment buildings with construction cost or purchase
price over 1 million
• New construction Remodels/rehabilitations after 1986
Purchase of existing facility after 1986
Types of Facilities That Can Benefit from
Cost Segregation Studies
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Warehouses
Grocery Stores
Retail
Banks
Restaurants
Apartments
Offices
Hospitals
Manufacturing
Sports/Recreation
Hotels
Leaseholds
Average Percentage of
Reclassified Costs
Benefits of
Cost Segregation
Cost segregation studies enable owners to:
• Increase cash flow through a reduction in federal
income tax liability
• Justify accelerated depreciation of certain
improvements
• Write off the amount of allowable past accelerated depreciation
over 1 year by filing Form 3115
How Much Have Local
Property Owners Saved?
Representative recent studies:
Facility
Office Building
Retail Center
Art Gallery
Cost
Cumulative
Present Value
$ 5.1 million
$18.0 million
$ 3.0 million
$ 150,000
$1,200,000
$ 90,829
The average return is approximately $11 for every $1 invested in a study.
Bonus Depreciation Means
Greater Savings
• 50% of the cost of qualifying assets purchased after May 6,
2003 and placed in service before 2005 can be depreciated in
the first year. 30% of the cost of qualifying assets placed in
service between September 10, 2001 and May 5, 2003 can be
depreciated in the first year. Qualifying assets are generally
assets with a depreciable life of 20 years or less. Bonus
depreciation applies only to original use of the asset.
• Watch out for used equipment!
Which Elements Are
Considered Structural?
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Walls partitions, floors, ceilings
Windows and doors
Central air conditioning and heating units
Plumbing and plumbing fixtures
Electrical wiring and fixtures
Chimneys
Stairs, escalators, and elevators
Sprinkler systems, fire escapes
Other components relating to building maintenance
Personal Property Must Meet
Specific Criteria
• Is the property capable of being moved, and has it in fact
been moved?
• Is the property designed or constructed to remain
permanently in place?
• Are there circumstances which tend to show that the
property may or will have to be moved?
Personal Property Must Meet
Specific Criteria (continued)
• How substantial a job is removal of the
property and how time consuming is it?
• How much damage will the property sustain
upon its removal? What is the manner of affixation of the
property to the land?
Source: Hospital Corporation of America v. Commissioner
Examples of Personal Property
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Architectural millwork
Carpeting and padding
Electrical wiring to personal property
Plumbing service to personal property
Moveable partitions
Security systems
Exhaust equipment
Decorative lighting
Emergency generators
Land improvements
Signage
Wall coverings and window treatments
Methodology Is
Crucial to IRS Acceptance
In its memorandum of April 1, 1999 regarding the HCA
case, the IRS notes: “An accurate cost segregation study
may not be based on non-contemporaneous records,
reconstructed data, or taxpayer’s estimates or
assumptions that have no supporting records.
Thus cost segregation studies should be
closely scrutinized by the field.”
What Qualifications Are Needed
to Prepare a Supportable Study?
The cost segregation study preparer must:
Understand applicable Internal Revenue Code,
Tax Court rulings, IRS Actions on Decisions,
Chief Counsel’s Advisories, Technical Action
Memoranda, and other documents relating to
depreciation of personal and real property
What Qualifications Are Needed to
Prepare a Supportable Study (con’t)
• Understand the procedures necessary to develop a report
that can withstand IRS scrutiny
• Understand architectural documents
• Understand construction methods and materials
Which Properties Are Not Candidates
for Cost Segregation?
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Properties that will be sold within two years
Properties with construction cost or purchase
price below $1 million
Properties owned by entities that do not have
taxable income
Passive Activity Losses
• If the beneficial owner that holds the property generates a
passive loss, this loss may not be deductible in the current
year unless there is also passive income. A loss is
considered passive if the taxpayer does not meet “material
participation” standards. The passive activity loss may be
carried forward indefinitely to offset passive income
generated in future years.
At-Risk Loss Rules
• The difference between the net loss and the owner’s basis will
be non-deductible if a loss generated for the current year
exceeds the owner’s basis in the company. Example: A loss
creates a negative capital account in a partnership or LLC, and
the partner has no basis in underlying debt on the property.
The at-risk loss may be carried forward indefinitely to offset
future income in the property.
Why Select Gerber & Co.
for Cost Segregation Studies
Our firm's accounting professionals - working closely
with our specially trained engineers - have reviewed
over $5 billion worth of property for Cost Segregation.
Our client base includes a broad spectrum of industries
that can benefit and have obtained benefits from these
studies
We have personnel who understand construction
methods and documents.