Cost Segregation assists property owners in reducing federal income tax liability by reclassifying certain building and land improvement asset costs into shorter 5, 7, and 15-year recovery periods. The objective of a cost segregation study is to identify, segregate and value the real and personal property assets included in a project in order to maximize depreciation and thereby generate significant tax benefit.
Studies may also be used to assist management in properly accounting for deductions related to the abandonment or retirement of purchased assets (see Asset Abandonment). This includes a determination of the magnitude of the improvements available for abandonment write-off, as applicable under IRS Section 168(i) (8).
In addition to reducing Federal income tax liability, another benefit derived from a cost segregation study may include lower sales tax exposure. For example, some states grant tax exemptions for tangible personal property used in the manufacturing process or research and development. These type assets are typically identified and valued as part of a study for state and local tax purposes.
Federal Tax Depreciation
Current tax law holds that any addition or improvements to non-residential Real Property already in service is depreciated using the straight-line method over a 39-year recovery period. Residential Real Property is depreciated using the straight-line method over a 27.5-year recovery period.
If improvements to property can be classified as tangible personal property, MACRS (Modified Acceleration Cost Recovery Systems) depreciation is calculated using shorter recovery periods and applicable accelerated methods. Current MACRS and property classifications for federal income tax purposes are outlined in the 1986 Tax Reform Act (TRA 86) Cost Recovery Systems and the Omnibus Budget Reconciliation Act of 1993, along with the Internal Revenue Service Code. These guidelines identify items considered to be Section 1245 (5-7 year life) and Section 1250 (ADR midpoint life of 27.5 years or more) property.
Cost Segregation Studies and Federal Tax Benefits
Cost segregation is a complex process, and our senior cost engineering staff works with you to bridge the gap between construction and accounting to ensure your tax benefits are maximized. Our studies are provided by experienced professionals who will:
· Work with you and your accountant to procure data related to acquisition or construction.
· Analyze project costs, contractor payment applications, and other cost documentation for reconciliation to property accounting records.
· Perform cost engineering analysis utilizing project construction plans, construction cost manuals, and conduct a physical inspection of the property to document findings.
· Determine the appropriate tax life for building and land improvements by researching and identifying relevant case law and tax code.
· Issue a written report containing project property data, related tax information, and asset value schedules that support our findings.
The potential federal tax benefit or payback for identifying and reclassifying each dollar of 39-year Real Property is:
· 5-year Personal Property - about 22 cents for each dollar reclassified;
· 7-year Personal Property - about 18 cents for each dollar reclassified;
· 15-year Real Property - about 10 cents for each dollar reclassified.
Our project experience suggests that when the tax savings from a cost segregation study are used to reduce the cost of construction, taxpayers may effectively reduce the overall cost of construction by 2% to 6%.
Eastern Valuation Associates provides cost segregation studies for traditional real estate investment such as office and retail shopping centers, hotels, apartment and restaurant properties and manufacturing facilities as well as special purpose properties such assisted living centers, recreational facilities, casinos, and golf courses.
Clients can benefit from the increased cash-flow derived from the tax benefits of accelerated asset depreciation, and a cost segregation study is highly recommended for real estate owners who:
· Constructed and placed in service new real estate assets;
· Purchased real estate assets or made additions or improvements;
· Expect to hold these assets for more than three years;
· Have historic real estate asset costs that have not been segregated for depreciation purposes.
The best time to apply a cost segregation study is when assets are acquired or placed in service. Studies can be used for new and existing properties, and can be applied to both older and newly acquired holdings. Studies also provide benefits for such purposes as purchase price allocation, improved fixed asset records, and asset retirement.