Cost segregation studies can result in tax savings - Insiders Outlook - Brief Article

Can you benefit from accelerating depreciation on your real estate holdings? Have you purchased or constructed property after 1986? Is the cost of your property at least $750,000?

If you can answer yes to these three questions, then you're a prime candidate for a unique asset reclassification strategy known as-cost segregation. Cost segregation studies have generated millions of dollars in current federal income tax savings to real estate firms. Yet, because of the complicated nature of the study, which requires a tax expert with intimate knowledge of the IRS code and a network of resources, only a relative handful of CPA firms in the New York/New Jersey metropolitan area provide the service to their real estate clients.

Client benefits, however, can be substantial. Consider the impact on a company owning a $5 million building: A 5% benefit, which is not uncommon, would generate $250,000 in tax-savings. Cost savings of anywhere from $50,000 to $2 million (in the case of one client who owns seven New Jersey office buildings) are typical.

How Cost Segregation Works

While personal property is usually depreciated over a five- to seven-year life, real property is typically depreciated over 39 years. With a cost segregation study, real estate owners can shelter large sums of income now rather than later by shifting certain property costs from a 39-year life to 15-year, 7-year and even 5-year life.

Construction-related soft costs have historically been lumped together as part of real property. However, by performing a cost segregation study, these soft costs can be allocated to various components of the property, many of which have shorter depreciable lives than the real property component. The result is a faster write off of costs previously included as real property.

Cost segregation studies can be performed on purchased buildings as well as newly constructed buildings. Studies can be performed for buildings placed in services as far back as- 1987, even if the year is "closed" for tax purposes. Recently issued IRS revenue procedures permit taxpayers that have claimed less than the allowable depreciation to claim the omitted amount over a four-year period. In addition, the segregated components continue to be depreciated over shorter lives going forward.

Savings derived from these studies flow directly to the bottom line in tax savings and cash flow.

Examples of Cost Segregation

These client case studies illustrate the tax savings benefits of cost segregation:

* A client acquired a $6 million warehouse facility in 1996. During the first four years of operations, the depreciation expense was originally calculated as $650,000. As a result of a cost segregation study performed in 1998, the company was able to increase by $250,000 its depreciation expense during the same period by decreasing the tax life for site improvements from 39 to 15 years. This resulted in tax savings and additional cash flow of more than $100,000 to the company.

* A $650,000 animal hospital was constructed in 1997. Depreciation expense during the first five years of operation was initially calculated as $75,000. As the result of a cost segregation study performed the following year, the tax life of construction related to the operation of the facility was reduced from 39 to 5 years. The company was able to increase its depreciation expense during this five-year period by $160,000. This resulted in tax savings and additional cash flow of more than $70,000.

* An office building costing $48 million was acquired in 1995. The landlord made tenant improvements of $2 million to the facility over the ensuing two years. As originally calculated, the depreciation expense from 1998 to 2001 was $5.05 million. A cost segregation study that identified such improvements as carpentry and wall coverings increased the depreciation expense by $2.3 million. This led to tax savings and additional cash flow of over $700,000.

COPYRIGHT 2002 Hagedorn Publication
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