Cost Segregation Studies, or Accelerated Cost Recovery, assists real estate owners and corporate executives in reducing federal income tax liability and thereby realize a significant increase in cash flow. This is accomplished by reclassifying certain building and land improvement asset costs into shorter 5, 7, and 15-year recovery periods in order to maximize depreciation expenses.
Federal Tax Depreciation
Current tax law holds that any addition or improvements to non-residential Real Property already in service is depreciated using the straight-line method over a 39-year recovery period. Residential Real Property is depreciated using the straight-line method over a 27.5-year recovery period.
If improvements to property can be classified as tangible personal property, MACRS (Modified Acceleration Cost Recovery Systems) depreciation is calculated using shorter recovery periods and applicable accelerated methods. Current MACRS and property classifications for federal income tax purposes are outlined in the 1986 Tax Reform Act (TRA 86) Cost Recovery Systems and the Omnibus Budget Reconciliation Act of 1993, along with the Internal Revenue Service Code. These guidelines identify items considered to be Section 1245 (5–7-year life) and Section 1250 (ADR midpoint life of 27.5 years or more) property.
Cost Segregation Studies and Federal Tax Benefits
Cost segregation is a complex process, and our senior cost engineering and real estate valuation specialists can work with you to bridge the gap between construction and accounting to ensure your tax benefits are maximized. Our studies are provided by experienced professionals who will:
- Work with you and your accountant to procure data related to acquisition or construction.
- Analyze owner project costs, contractor payment applications, and other cost documentation for reconciliation to property accounting records.
- Perform cost engineering analysis utilizing project construction plans, construction cost manuals such as RS Means and Marshall & Swift, and conduct a physical inspection of the property to document findings.
- Determine the appropriate tax life for building and land improvements by researching and identifying relevant case law and tax code.
- Issue a written report that contains project property data, related tax information, and excel spreadsheet asset value schedules that support our findings.
The potential federal tax benefit or payback for identifying and reclassifying each dollar of 39-year Real Property is:
- 5-year Personal Property – about 22 cents for each dollar reclassified;
- 7-year Personal Property – about 18 cents for each dollar reclassified;
- 15-year Real Property – about 10 cents for each dollar reclassified.
Our project experience suggests that when the tax savings from a cost segregation study are used to reduce the cost of construction, taxpayers may effectively reduce the overall cost of construction by 2% to 6%.
In addition to reducing federal income tax liability, another benefit derived from a cost segregation study may include lower sales tax exposure. For example, some states grant tax exemptions for tangible personal property used in the manufacturing process or research and development. These types of assets are typically identified and valued as part of a study for state and local tax purposes.
Federal Appraisal, LLC provides cost segregation studies for traditional investment and corporate real estate such as office and retail shopping centers, hotels, apartment and restaurant properties as well as special purpose properties such as industrial facilities, assisted living centers, resorts, casinos, golf courses, and power generation facilities.
You can benefit from the increased cash-flow derived from the tax benefits of accelerated asset depreciation, and a cost segregation study is highly recommended for real estate owners who:
- Constructed and placed in service new real estate assets;
- Purchased new real estate assets or made additions or improvements;
- Expect to hold these assets for more than three years;
- Have historic real estate asset costs that have not been segregated for depreciation purposes.
The best time to apply a cost segregation study is when assets are acquired or placed in service. Studies can be used for new and existing properties, and can be applied to both older and newly acquired holdings. Studies also provide benefits for such purposes as purchase price allocation, sales tax savings, lower property taxes, improved fixed asset records, and asset retirement.
Cost Segregation allows taxpayers to substantially increase their after-tax cash flow and defer federal and state income taxes by accelerating depreciation expenses. Non-segregated residential real estate is depreciated over 27.5 years and a non-segregated commercial real estate is depreciated over 39 years. A cost segregation study will identify and reclassify the elements of the real estate. Some real estate elements have depreciation schedules of 5, 7, and 15 years, which are dramatically shorter than 27.5 and 39 years. Cost Segregation is one of the most significant tax reducing opportunities available in the real estate industry.
Federal Appraisal, LLC provides cost effective, USPAP-compliant cost segregation studies that are certified by MAI’s, ASA’s and that are conducted by professionals with engineering backgrounds.
We recommend examining a company’s cost segregation program, whenever the company:
- acquires real estate
- builds a new asset
- installs leasehold improvements
- installs additions or expansions, or renovates an existing asset
- discovers historical costs have not yet been segregated
The Cost Benefit Test for Cost Segregation
1. Can your organization benefit from sheltering income?
2. Did your organization buy or build any facilities at a cost of more than $2,000,000, since 1986?
3. Does your organization expect to hold the facilities for more than three years?
If you answered “yes” to these questions, then your organization will benefit from a professionally prepared cost segregation study.
Cost Segregation studies may provide other benefits, such as purchase price allocation, sales tax savings, lower property taxes, and improved fixed asset records and registers.
Cost segregation can be used for new and existing properties, and can be applied to both older or newly acquired holdings. The best time to apply cost segregation is when assets are acquired or placed in service.
Cost segregation is complex because of the numerous depreciation classifications and the engineering and real estate expertise required to determine the appropriate classification.
In addition to providing Cost Segregation services for traditional investment and corporate real estate, Federal provides Cost Segregation services for special purpose properties, such as power generation facilities and manufacturing facilities.
See Business Valuation/Asset Type page for more information.