Using Cost Segregation Studies to Improve the Bottom Line amid Economic Uncertainty
Grant, David, Real Estate Issues
To say that 2001 was a turbulent year would be an understatement of significant proportions. Virtually every aspect of American life was dramatically altered during the past year, and the commercial real estate industry was certainly no exception. At the outset of 2001, an unprecedented economic expansion fueled dynamic growth and prosperity throughout the industry. As the year drew to a close, however, the industry found itself at the mercy of a shallow, yet broad recession, the effects of which have begun to reverberate on a national scale. While uncertainty will undoubtedly be among the buzzwords of the 2002 economy, one thing can be said with absolute certainty--everyone will be looking for innovative ways to improve the bottom line.
While not a revolutionary new idea, the Cost Segregation Study (CSS) is an extremely valuable tool that often allows owners and investors to properly identify and depreciate property assets and realize significant, immediate tax benefits. Although the 2001 tax season is coming to a close, it is never too late to evaluate whether or not a CSS can benefit you.
HOW MUCH CAN BE SAVED?
Cost segregation studies have generated millions of dollars in current federal and state income tax savings to owners of real estate. However, given the complicated nature of the study, it requires a tax expert with an intimate knowledge of the IRS code and the relevant tax cases, as well as a network of resources to maximize the benefits. To date, a relatively small number of CPA firms provide this service to their real estate clients.
The amount of the benefits from performing a CSS will vary depending on i) the type of property; ii) the cost of the property; and iii) the year it was placed in service.
Our experience in performing cost segregation studies for the real estate industry indicate that the savings can be as high as 5 percent of the asset cost. Savings of anywhere from $50,000 to $1 million, or more (depending on the type and size of facility) are routine.
WHAT TYPE OF PROPERTY BENEFITS THE MOST?
While almost every type of real estate can benefit from a CSS, experience indicates that certain types of property yield highest tax saving benefits from a CSS. Those properties include specialty use buildings, such as medical facilities, manufacturing facilities and high-end office buildings, to name a few. Warehouses and industrial properties tend to yield lower benefits, while residential garden apartments fall somewhere in the middle. We have found that even large tenant fit-outs can qualify for substantial benefits as well.
WHAT IS A CSS?
Almost anyone can identify and properly depreciate items such as office furniture and equipment over seven years for federal tax purposes. However, a high percentage of construction related costs, sometimes as high as 40 percent, are too commonly lumped into the building component of the property and depreciated on a straight-line basis over 39 years.
A CSS is the process of reviewing and identifying the costs a company incurs to acquire, construct, or expand its real estate holdings. It identifies the specific types of assets being placed in service and often leads to a cost allocation that assigns part of the cost to 15-year real property and seven- or five-year personal property. An analysis of costs can be conducted from either the detailed construction records-in the case where such records are available-or by using qualified appraisers, architects, or engineers to perform the cost allocation analysis. In both instances, a tax expert is also needed to identify the specific types of property that will qualify as shorter-lived assets. …