Cost Segregation- General FAQs
What is involved in a cost segregation study?
A quality Cost Segregation Study evaluates all information, including available records, inspections, and interviews, and presents the findings clearly and well-documented.
Our process for conducting a detailed Cost Segregation includes a review of all cost details for the property, including but not limited to the general contractor's application for payment, construction invoices, change orders, depreciation schedules, and appraisals.
When should a Cost Segregation study be conducted?
A Cost Segregation study can be completed any time after the purchase, remodel or construction of a property. However, the optimum time for a study for new owners is during the year a building is constructed, purchased or remodeled. For investors who are in the planning phases of construction or remodeling, the best time to consider a Cost Segregation study is before the infrastructure of the building is set. LTRS offers a free preliminary analysis that can help determine the right timing and strategy for any investor.
What should I consider when selecting a Cost Segregation provider?
It would help if you always read the bio and resume of the persons signing your Cost Segregation study. Ensure they are certified with the American Society of Cost Segregation Professionals (ASCSP). The Certified Cost Segregation professional designation is CCSP and comes after the engineer's name. Any designation less than that is substandard. Just like you would only use a CPA to file your tax return, you should only use a CCSP to conduct your Cost Segregation study.
Will the company be available if I get audited by the IRS?
Any company can give you a Cost Segregation report with results that save you a lot of money; the real question is whether it will stand up to IRS scrutiny. The actual value of your fee is how easy (or painful) the audit process goes. Every Cost Segregation company will say they stand behind their work, but how can you know what will happen when the IRS audits the report? Using a larger company that has been in business for many years should help you understand that it can successfully defend your study against an IRS audit.
Look at their client profile. Bigger, well-known clients are more likely to be audited by the IRS. A company without high-profile clients probably doesn't have much experience dealing with the IRS. Some companies mislead consumers by stating they've worked for companies like Walgreens, McDonald's, or Holiday Inn when they have only worked with smaller franchisees or landlords that lease their buildings to such companies.
Does the LTRS have tax experts who can help if my CPA has questions?
Yes, LTRS has tax experts on staff with over 100 combined years of experience filing tax returns. This is important because so many unique fact patterns and situations can impact how the Cost Segregation deductions will flow through on your tax return.
A Cost Segregation engineer does not necessarily know enough about tax to truly understand how the Cost Segregation deductions will specifically impact you. Using a firm like LTRS with tax experts on staff will save you money if your CPA has any questions regarding your situation.
How long will it take to complete the study?
A Cost Segregation study will typically take 45-60 days to complete, depending on how quickly we receive the needed information.
How much will a Cost Segregation study cost?
The fee for a Cost Segregation study will vary depending on the building size, building type, number of tenants, and other physical characteristics. Typically, fees can range from $5,000 to $15,000.
How is depreciation impacted under the Alternative Minimum Tax (AMT) system?
Generally, for improvements placed in service after 1998, personal property identified in a Cost Segregation Study will require depreciation to be calculated using a 150% declining balance method instead of the 200% declining balance method. Although the acceleration of depreciation is slower under the 150% declining balance, the benefits of a Cost Segregation Study are not impacted significantly since the recovery periods remain the same. The calculations are more complex for improvements placed in service before 1998, and benefits from a Cost Segregation Study are likely to be somewhat lower than initially anticipated.
I have just constructed a building; the general contractor's invoice has already broken down the costs. Can't my CPA conduct the study?
In September 2004, the IRS released the first iteration of the Cost Segregation Audit Techniques Guide to clarify what they are looking for in a Study. Of the 13 essential elements, the very first item the IRS lists is "Preparation By An Individual With Expertise And Experience." They further explain the following:
"The preparation of cost segregation studies requires knowledge of both the construction process and tax law involving property classifications for depreciation purposes."
"… a study by a construction engineer is more reliable than one conducted by someone with no engineering or construction background. However, the possession of specific construction knowledge is not the only criterion. Experience in cost estimating and allocation and knowledge of the applicable law are other important criteria."
"A quality study identifies the preparer and always references his/her credentials, experience, and expertise in the cost segregation area."
The IRS stresses experience and expertise as being so important because they recognize that there are no set rules you can use to determine if the property is eligible. For example, a light fixture in one room may qualify as 1245 property (property eligible for a shorter accelerated depreciable life), while the same light fixture in the next room may not qualify because of various facts and circumstances on how and why it's being used. This applies to every asset in the building, and the onus (to prove and substantiate that each asset qualifies) is on the taxpayer. This is done by understanding each asset's characteristics and the circumstances for which legal authority can support your position on each asset. Because this is both a time-consuming and confusing task, it is the exact reason why all the major accounting firms in the country have specially trained non-CPA professionals performing these studies. Below are citations from the IRS on this issue.
"Determining whether an asset is a structural component or tangible personal property is a facts-and-circumstances assessment, and as such, no bright line test exists." CCA 199921045; 5/28/1999
"A plethora of legislative acts, court decisions, and Service rulings have produced complex and often conflicting guidance concerning property qualifying" ATG; Section 1
"It cannot be overemphasized that the classification of assets is a factually intensive determination." ATG; Section 2
Taxpayers or CPAs attempting to perform a study will likely misclassify assets, resulting in lower tax benefits and/or more exposure during an audit. Additionally, an engineer can provide significantly more tax benefits by further breaking down construction costs through an analysis of the blueprints, a thorough facility inspection, and proprietary software and tools.
Finally, another difficulty for a non-qualified professional is the allocation of construction "soft costs." These "soft costs," also known as "indirect costs," are intangible costs that are incident to the construction of a facility. Indirect costs must be allocated proportionately to the basis of the specific assets to which they relate. For instance, a cost for HVAC design work must be allocated pro-rata to particular HVAC "hard costs" (tangible costs). Because of the intermixing of services from various vendors within a construction project, it's challenging to determine the appropriate allocation and then correctly apply those calculations without a software program designed specifically for that purpose.
The IRS has reviewed these studies for various tax purposes since the 1950's. They have concluded (and stated on record) that this type of analysis is too complex for a non-qualified professional to perform. Below are just some of the many additional citations where the IRS states that a third-party qualified professional should conduct a study.
"Therefore, it is proper for the taxpayer to use a third party cost analysis to allocate costs to a building's structural components" Private Letter Ruling 7941002, 6/25/1979
"The use of cost segregation studies must be specifically applied by the taxpayer" CCA 199921045; 5/28/1999
What's the benefit of addressing abandonment issues in a Cost Segregation Study?
By quantifying all property, including "structural components" by suite, our analysis will allow for identifying costs that can be written off for future tenant abandonments. For a fully improved property acquired after 1996 with no cost documentation on those improvements, it's impossible to take advantage of these benefits without a Cost Segregation Study. Although this is beyond the scope of the regular study, it is standard in our product and can significantly increase total tax benefits by as much as three times!
I did a 1031 exchange on my property. Will a Cost Segregation Study still save me money?
Nearly half of the Cost Segregation Studies conducted at LTRS involve properties in a 1031 exchange. However, there are situations where a 1031 exchange will negate the benefits of a Cost Segregation Study. Our CPAs have an in-depth knowledge of how a study interacts with an exchange and will let you know how using both tax strategies will affect your cash flow.
I plan on selling my property very soon. Does Cost Segregation make sense to me?
If you conduct a Study on a property you plan to sell in a taxable transaction, you may have to recapture your accelerated depreciation deductions. However, this depends on when the property was acquired and the value of the accelerated depreciation property upon disposition (i.e., you may be able to create a significant deduction and only have a smaller amount of recapture). Better still, if you intend to enter into a like-kind exchange (a non-taxable transfer of your property for another), you will not have depreciation recapture issues until you sell the replacement property. In this situation, a Cost Segregation Study could be highly beneficial. In addition, conducting a Study in the year of exchange could allow you to pull out some cash (taxable boot) without creating any tax liability. Our tax experts will work with you or your CPA to assess your situation and inform you of your options.
How long do I need to hold on to the property for Cost Segregation to make sense?
If the intention is to sell for cash, we generally recommend Cost Segregation for clients holding a property for a minimum of 3-5 years. We can calculate the "break-even" point to determine the benefits of a Cost Segregation Study based on how long you plan to hold the property.
I have several partners in this property. There's no way they will all agree to amend their returns to take advantage of the study. Is there another way?
Yes. An amended return is no longer necessary to fix depreciation in the prior year. The IRS has recently issued Revenue Ruling 2004-11, which allows a taxpayer to file a form 3115 Automatic Change in Accounting instead of an amended return. This allows the taxpayer to take any missed deductions in the current year. The same form is also used to fix depreciation on assets acquired as far back as 1987.
Will a Cost Segregation Study increase my chances of getting audited?
Not if you are taking depreciation, but you are allowed to, as identified by the IRS. The IRS has:
- Issued revenue procedures specifically outlining how Cost Segregation can be used
- Identified appropriate asset-class lives that can be taken
- Specified guidelines on how the accountant should file for an automatic change in accounting method to account for missed depreciation
Why has my accountant not performed a Study already?
The IRS recognizes that a Study requires engineering expertise. While an accountant may know about taxation, an engineer must interpret blueprints, assess construction methods, inspect the building, and estimate components. Additionally, since the same asset can qualify in one building and not another, knowledge of numerous IRS rulings is needed to ensure assets are being depreciated correctly for a specific situation.