Depreciate property improvements correctly with cost segregation

							Title:
Depreciate property improvements correctly with cost segregation

Word Count:
935

Summary:
A cost segregation study allows property owners to both defer and reduce
federal income taxes. When properly performed by an appraiser with
expertise in cost segregation, this is a conservative tax planning tool
which reduces federal income taxes by properly allocating the cost basis
between land, 5-year, 7-year, 15-year, 27.5-year and 39-year property.


Keywords:
appraisal, real estate, cost segregation, oconnor


Article Body:
Most commercial building owners are grossly overpaying federal income
taxes because they are not depreciating their property as quickly as they
should. A cost segregation study allows property owners to both defer and
reduce federal income taxes. When properly performed by an appraiser with
expertise in cost segregation, this is a conservative tax planning tool
which reduces federal income taxes by properly allocating the cost basis
between land, 5-year, 7-year, 15-year, 27.5-year and 39-year property.

Cost Segregation Study Benefits
Benefits of a cost segregation study are substantial, immediate and
enduring. Year 1 federal income tax savings are typically at least two
times the cost of a cost segregation study. In many cases they are five
to fifty times the cost of the study. The present value of federal income
tax savings for a property held for ten years are typically at least ten
times the cost of the study. In many cases, the present value of tax
savings as much as 30 to 50 times the cost of the report. The cost
segregation study is only required once. Its cost is not recurring, but
the benefits are recurring during the term of property ownership. A cost
segregation study can also materially reduce local property taxes by
separating real and personal property for newly constructed properties.

Detailed Example
Preparing a cost segregation study requires only a limited time
commitment from the owner, perhaps 10 to 15 minutes. This limited
commitment of time results in substantial tax savings, which are both
conservative in approach and well documented. Some owners believe their
accountant is properly segregating components into the proper
classifications. Many accountants cannot thoroughly research this highly
specialized field to understand the myriad of items which can be
segregated and are inadvertently overstating their client’s income tax
liability. Furthermore, not obtaining a cost segregation study increases
exposure in case of an audit since there is no clear audit trail. A cost
segregation study prepared by an appraiser with expertise in land
valuation, construction costs and market value clearly documents each of
these items. Further, a cost segregation expert can almost certainly
sharply increase allowable depreciation.

Who Benefits from a Cost Segregation Study
If you own real estate and pay federal income taxes or expect to during
the ownership period for the property, you will benefit from the results
of a cost segregation study. This is true whether the ownership to the
real estate is titled in a corporation, limited partnership or limited
liability corporation. For syndicators, a cost segregation study is
appropriate if limited partners will receive material net taxable income
during the holding period even if the general partner does not currently
pay federal income taxes. The cost segregation study will increase
depreciation shield, thereby decreasing and deferring federal income
taxes for the investors.

Decreasing and Deferring Federal Taxes
Since a cost segregation study decreases and defers federal income taxes,
let’s review the long-term impact of this deferral. When the property is
sold, capital gains tax will be due if the owner does not enter into a
1031 exchange. However, capital gains tax rates are typically 20% - 25%
for high net worth individuals, while the ordinary income tax rate is
35%. In addition, the deferral during the ownership period has material
benefits because of the time value of money. All investors would much
rather pay a 20% - 25% tax rate when an asset is sold as opposed to
paying a 35% tax rate today.

When Should You Obtain A Cost Segregation Study
The best time to obtain a cost segregation study is when you build or
purchase a property. Documentation is most readily available for
performing a study and a contemporaneous property inspection can be
performed to best document results. However, there are options to perform
a cost segregation study for property which has been developed or
purchased previously.

Elements of Preparing a Cost Segregation Study
The appraiser starts by gathering documents from the property owner and
performing a site visit. As necessary, depending on the special-use
property found during the site visit, the appraiser would confer with tax
counsel and review relevant tax court decisions. For newly constructed
properties, most of the costs detail can be obtained from construction
draws or invoices from contractors. For existing properties, the
appraiser performs a quantity take-off for 5-year, 7-year, and 15-year
property and estimates replacement cost using recognized sources. The
appraiser then values land, 5-year, 7- year, 15-year, 27.5-year and 39-
year property based upon inspection, analysis and IRS regulations and
court rulings.

Does this only apply to large owners?
Both large and small owners of income property or owner-occupied
commercial property can benefit from a cost segregation study. Commercial
properties with a cost basis of at least $200,000 will likely see a
material benefit in excess of the cost from a cost segregation study. In
fact, owners of single-family rental homes can probably achieve
worthwhile benefits by obtaining a cost segregation study.
Qualifications to Consider when ordering a Cost Segregation Report
The ability to value land and real property are critical elements when
engaging a tax reduction expert to perform a cost segregation study. In
addition, it is essential they have a detailed understanding of rules for
classifying 5-year, 7-year, 15-year, 27.5-year and 39-year property. The
ability to justifiably increase short-life depreciation materially
increases the benefits of a cost segregation study. While most accounting
professionals have a rudimentary understanding of the 5-year, 7-year and
15-year property classifications, few have a detailed understanding of
this highly specialized niche. Be certain the report provider has
scrutinized both the federal income tax code and the meaningful tax court
cases to allow you to maximize your depreciation and minimize your
federal income tax liability.