What is a Cost Segregation Study?
Cost Segregation is a strategic tax planning
tool that allows companies and individuals
who have constructed, purchased or remodeled
a commercial property to accelerate depreciation.
By doing so, this helps to increase cash flow
and defer federal and state income taxes.
Cost segregation allows the tax-payer to identify
assets and project related costs that can
be reclassified into shorter life classes
than those which they are currently classified.
Typically these components are capitalized
under a useful life class of 39 years, meaning
that only 1/39th is depreciated each year
using a straight line depreciation method.
A cost segregation study will, in most cases,
segregate and reclassify 20% – 50% of the
total project costs into classes of 5, 7,
and 15 year depreciation life. Not only does
this accelerate depreciation, but it also
can lead to other benefits such as a reduction
in property taxes, decreased insurance premiums,
future bank loan qualifications and a better
general understanding the true asset life
span and future replacement costs.
Why Should I Have and Engineer Perform the
Study?
A quality cost segregation study is based
on a detailed engineering analysis. This analysis
involves a thorough review of relevant information
such as cost data, building plans, and lease
agreements, as well as an on-site inspection
of the property conducted by a qualified professional,
preferably an engineer. Following document
review and the site visit, the engineer(s)
will produce a detailed breakdown of costs
and properly allocate them to the appropriate
recovery periods (primarily 5, 7, 15, 27.5/39-year)
depending on the facts and circumstances of
the project. For newly constructed or renovated
properties, project soft costs such as architectural
and engineering fees, and builder’s overhead
and profit are then allocated in accordance
with the findings of the study. It should
be noted that a quality engineering-based
study will address ALL depreciable costs,
NOT just those that qualify for a shorter
recovery period (residual method). Once all
of the costs have been accounted for, the
numbers must be properly reconciled to the
total depreciable cost basis.
Additionally, most engineering based cost
segregation studies can break out approximately
30% - 50% of the buildings cost into shorter
recovery periods. As shown in the graph.
How Does Cost Segregation Work?
A cost segregation study should be performed
by an engineer with a background in facility
systems, construction and valuation, as well
as a vast knowledge of building component
classifications allowable by the IRS. Blue
Ray will first produce a preliminary cost
segregation benefit analysis to ensure that
our cost segregation services are beneficial
to the client’s particular project. Our
engineers will gather documents such as construction
plans, contractor invoices, purchase closing
statements, survey details, appraisals and
depreciation schedules. We will then perform
an in depth physical inspection of the property
to compare what was actually built or purchased
against the plans and take photographs that
will document and back up the cost segregation
study analysis. Following the site visit and
document review, our engineer will create
a detailed breakdown of take-off quantities
and associated costs and properly allocate
them to the appropriate recovery period to
which is allowable by the IRS. The results
will then be aggregated and presented in a
format cost segregation report which includes
all calculation details, relevant case law
data, definitions, and photo documentation.
What Types of Property is Right for Cost Segregation?
Typically any type of commercial property
placed in service after December 31, 1986
will qualify for a cost segregation study.
Restaurants, Professional Offices, Warehouse
Facilities, Retail Facilities, Medical Clinics
and Auto Dealerships are good examples. Be
aware that properties purchased even 10 to
15 years ago can receive huge year 1 benefits
from a cost segregation study. This is due
to the IRS allowance to look-back and catch
up on all of the depreciation that would have
been available if the study would have been
performed in the initial in-service year.
This is known as a look back cost segregation
study and is very often over looked by property
owners, CPAs and accountants.
How Much Money Will I Save After the Cost
Segregation Study?
It is very common to generate several thousand
or even hundreds of thousands of dollars in
real liquid net present value savings. The
average cost segregation study will reallocate
anywhere from 20 – 50% of the combined property
assets, leading to first year realized returns
of higher than 10 to 1 on your cost segregation
study investment. Blue Ray will gladly provide
a free cost segregation analysis to determine
the potential ROI to be expected by applying
cost segregation strategies to that particular
property and owner specific tax situation.
