Engineering-Based Cost Segregation

What is Cost Segregation?

A Cost Segregation Study (CSS) is a strategic tax planning tool that allows companies and individuals who have constructed, purchased, or remodeled a commercial property to accelerate depreciation. By doing so, this helps to increase cash flow and defer federal and state income taxes. The goal is to identify assets and project related costs that can be reclassified into shorter life classes than they currently fall under.

Typically, these components fall under a life class of 39 years (27.5 for residential), meaning they are depreciated over 39 years using a straight-line depreciation method. A CSS will in most cases segregate and reclassify 20% - 40% of the total cost of the project, placing the property into classes of 5, 7, and 15-year depreciation life.

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How Does Cost Segregation Work?

A cost segregation study must be performed by a qualified engineer experienced with cost segregation. The engineer will inspect the property, quantify, and estimate the value of each component, and assign class lives per IRS rules. This information is compiled into a final report along with calculation details, methodology, relevant case law data, definitions, and photo documentation, that your CPA will use to file your tax returns.

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What Types of Property Qualify?

Property placed in service after December 31, 1986

Typically, any type of commercial property placed in service after December 31, 1986 will qualify for a Cost Segregation Study. Below are typical reallocation percentages for various property types.

# Building Type Percentage Range
1 Apartment / Assisted Living 20% - 40%
2 Automobile Dealership 25% - 50%
3 Bank 25% - 35%
4 Casino 30% - 50%
5 Cold Storage 25% - 45%
6 Distribution Center 15% - 30%
7 Food Processing Facility 20% - 40%
8 Golf Course 25% - 40%
9 Hospital 25% - 35%
10 Hotel 25% - 40%
11 Industrial 20% - 40%
12 Manufacturing 20% - 40%
13 Medical Office 25% - 40%
14 Office 20% - 35%
15 Restaurant 20% - 40%
16 Shopping Center 25% - 40%
17 Self-Storage Facility 15% - 40%
18 Service Station 30% - 40%
19 Warehouse 15% - 30%

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Bonus Depreciation

The expansion of the bonus depreciation rules was one of the most significant taxpayer-friendly surprises in the Tax Cuts and Jobs Act (TCJA). The bonus depreciation provision allows a taxpayer to immediately deduct a certain percentage of the cost of qualifying property in the year the property is acquired rather than capitalizing that cost and depreciating it over a period of years. This applies to MACRS property with a class life of 20 years or less. Thus, any property identified as 5,7, or 15-year class life property can be fully depreciated year 1, until the rates are reduced in 2023.

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Case Studies

Case Studies Coming Some.

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Principle Elements of a Cost Segregation Study

• Preparation by An Individual with Expertise and Experience, Preferably a Licensed Professional Engineer
• Detailed Description of The Methodology
• Use of Appropriate Documentation
• Interviews Conducted with Appropriate Parties
• Use of A Common Nomenclature
• Use of A Standard Numbering System
• Explanation of The Legal Analysis
• Determination of Unit Costs and Engineering "Take-Offs"
• Organization of Assets into Lists or Groups
• Reconciliation of Total Allocated Costs to Total Actual Costs
• Explanation of The Treatment of Indirect Costs
• Identification and Listing of Section 1245 Property
• Consideration of Related Aspects (e.g., IRC § 263A, Change in Accounting Method and Sampling Techniques)
• Identification of all Units of Property

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Frequently Asked Questions

How Much Money Will I Save?
It is not uncommon for a cost segregation study to generate hundreds of thousands or even millions of dollars in net-present value savings. The average study will allocate approximately 20% - 40% of the depreciable cost to shorter lives. For every $100,000 moved from 39-year to 5-year the 10-year net-present value savings is approximately $25,000.
Will I need to amend returns?
No. A cost segregation study can be performed on any property acquired after 1986, and any missed depreciation can be claimed in the current tax year by calculating the §481(a) catch-up depreciation and filing a Form 3115 – Change In Accounting Method.
Doesn’t my accountant already do cost segregation for me?
Probably not, at least not with the appropriate level of detail or defensibility. CPAs simply do not have the expertise necessary to properly break-out all the assets that are considered in a cost segregation study. And why should they? After all they are CPAs not engineers. That said, some accounting firms do have trained engineers on staff to perform cost segregation studies.
Will I get audited?
Cost segregation will not automatically trigger an audit. However, the IRS has been getting more aggressive about the review of cost segregation studies, specifically with respect to the methodologies being used and the qualifications of the preparer. Per the IRS Audit Techniques Guide, studies being performed by unqualified individuals and those using an abbreviated methodology will receive higher scrutiny than the ones performed by qualified professionals who use the detailed engineer approach.

Green Summit Engineering only produces Cost Segregation Studies utilizing the "Detailed Engineering Approach", and every report is signed and sealed by a Licensed Professional Engineer.
When is the best time for a cost segregation study?
The best time for a cost segregation study is typically the year the property is placed in service by the current owner. It is generally most beneficial to maximize depreciation deductions from year one.
How much does a cost segregation study cost?
The fee for a cost segregation study can vary greatly depending on the property type, size, and complexity. Green Summit bases its’ fees on the estimated time the project will require, and accounts for all other costs such as travel which is presented in our benefit analysis and engagement letter.
Can I use cost segregation on buildings I placed in service in the past?
Yes. Look-back studies can be performed on properties placed in service as far back as January 1, 1987. Of course, it may not make sense to perform a study on a property that was placed in service 20 years ago, unless significant improvements have been made. This is because most of the depreciation has been taken and the cost of do¬ing the study would not necessarily be worth the benefit derived. However, this is not always the case. The facts and circumstance will ultimately be the deciding factor.
What is the impact of a cost segregation study if I sell my property?
Regardless of whether you have had a cost segregation study performed or not, when you sell a property you will recognize either a gain or a loss. When you sell for a gain you pay taxes on that gain. The amount of tax is based on the capital gains rate for real property (§1250) and the taxpayer’s ordinary income rate for personal property (§ 1245). When a cost segregation study is performed, items that would normally be considered real property are instead allocated to personal property. The ordinary income rate can be higher or lower than the capital gain rate, depending on the situation. If higher, the amount of tax due upon a sale would most likely be more if a cost segregation study were performed. However, the financial impact of the cost segregation study will often outweigh the adverse effect of the ordinary income rate. The bottom line is that this is truly a “facts and circumstances” situation and will require some additional analysis on the front end.

It should be noted that Rev. Proc. 2008-52 includes a provision that allows taxpayer to benefit from cost segregation after sale, in the year of disposition. The recapture issues discussed above still apply, but this may be an opportunity worth considering, especially if you sold your property at a loss.