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Cost Segregation is an IRS endorsed tax strategy
that is simple and easy to understand. The purpose in having a Cost Segregation
Study performed is to allow owners to depreciate their commercial property in a
manner that is different from the standard method of accounting, which is 39
years. Let’s face it, if the owner were a 60-year-old property owner, how much
depreciation on the property would the owner realistically expect to enjoy? If
you think about this cynically, the Government is betting that the life of the
property, in terms of depreciation (39 years), is going to “outlive” most
property owners! So, wouldn’t it be nice to dramatically accelerate the
depreciation now so that the owner can take advantage of an immediate cash flow
in the current tax year? Well, now it can be done legally.
The actual basis for this new accelerated
depreciation method of accounting has a legal foundation dating back to 1997.
The important thing to know is that in order for anybody to take advantage of
this program, they must hire an independent 3rd party qualified engineering
firm to perform the Cost Segregation Study, according to the IRS Chief Counsel.
When owners elect to have a Cost Segregation
Study performed on their commercial building, it allows certain components of
the building assets to be accelerated from the standard 39-year depreciation
schedule into segments of 5,7, 15, and 27.5-year
increments. Some elements of the structure will remain at 39 years. In cases
where the amount of the identified accelerated depreciation exceeds the amount
of paid in tax from the current tax year, the commercial property owner is even
able to go back the two previous years in recouping monies that have already been
paid. If needed, this program even allows for a carry-forward of the
accelerated depreciation until it is used up.
So, what are the engineers actually doing? The
role of the engineering company is to: 1) Properly classify each of the
structural components of a commercial building, 2) Identify whether the
structural components are either permanent in nature or decorative, 3)
Determine whether each structural component is incidental to the operation and
maintenance of the building, 4) Apply the sole justification test for personal
property, and 5) Review applicable Legislative analysis and committee reports.
In addition, the engineers are responsible to have the skill-set to comprehend
and have knowledge of all the IRS and Court rulings on Cost Segregation Studies
from 1997 to the present.
Once a commercial property owner has decided to
move forward with a cost segregation study, the engineers will require some
specific documentation, such as architectural plans, blueprints, depreciation
schedule, etc. In addition, the owner or the owner’s CPA will be asked to
provide the cost basis of the property to ensure that the study is based on the
correct depreciation amount. When the study is complete and delivered, the
results of the study are reviewed with the owner and the CPA. None of the
owner’s internal staff is needed to perform the study and, with the exception
of the site visit and digital survey, the study is done in an unobtrusive
manner off-site. The Cost Segregation Study is a legally allowable depreciation
method. The key is to find an Engineering firm that specializes in these
studies and has staff members who are fluent as construction experts. The
engineers performing the study need to know what is “in the walls” and must
know how to apply the parameters of IRS approved industry standards and
systems. The Engineering analysis needs to analyze construction drawings,
standard cost systems, and construction analysis. An IRS memorandum even
suggests an “engineering cost segregation study” as the proper application.
The Cost Segregation Study typically takes 4-6
weeks. It can reduce the owner’s year-end taxes or reduce the owner’s current
quarterly estimated tax payments. Again, the Cost Segregation Study is
available to any commercial building. The program does not displace an
Accountant; but provides Accountants with a great way that they can endear
themselves to their clients by suggesting this acceptable accounting practice
that will maximize tax benefits for their clients.