Owners and lessees of real estate can achieve substantial tax benefits by using a popular asset depreciation technique called cost segregation. Cost segregation is the process of identifying personal property assets and/or tenant improvement costs that may be grouped with real property assets and separating their costs for tax reporting purposes. During a cost segregation study, ROMO identifies building costs that are typically depreciated over a 27.5 or 39 year period and reclassifies them into their appropriate asset classification (“asset life”). This reclassification allows for an accelerated depreciation deduction in the current year for these segregated building costs or tenant improvements. For example, costs for non-structural elements such as accent lighting, roofing, wall covering, carpet, portions of the electrical system and external site improvements such as parking lots, sidewalks, and landscaping, can often be depreciated over five, seven, or 15 years rather than over 27.5 or 39 years. This increases the depreciation deduction and lowers taxable income.
Who can take advantage of cost segregation? Any building owner who has purchased, constructed, expanded, or remodeled a building since 1987 or any lessee who has recently paid for tenant improvements. A study is typically cost effective if the purchase or improvements have occurred within the last seven years and the cost is greater than $750,000.
The benefits of cost segregation include the value of front–loaded depreciation deductions, write-offs of building components that need replacement and lower local realty-transfer taxes. Studies can be conducted retroactively for prior costs and purchases resulting in tax refunds. For many clients, the tax benefits can equal up to 10% of the building’s cost or improvements over a five year period.
ROMO will review the depreciation schedule and conduct an interview with the client in order to:
- Review the architectural drawings and specifications for buildings, tenant improvements and land improvements to identify all construction related assets that qualify for accelerated depreciation.
- Obtain and review copies of approved contractor pay requests, change orders and miscellaneous invoices in order to segregate these costs properly into the correct asset classifications for federal income tax purposes.
- Develop and provide a listing of construction costs for which a specific breakdown is required from the contractors involved. If the contractors are not able to provide this information, we will estimate those costs of the assets by using nationally recognized cost estimating manuals (this is especially the case for used facilities).
- Allocate a project’s indirect costs, such as architectural/engineering fees, permits, etc. to all project-related assets on a functional basis.
- Personally inspect the building and tenant improvements to ensure that all qualifying personal property and land improvements have been identified.
- Compile a schedule of MACRS depreciation.
- Apply relevant IRS regulations, rulings and court cases to support the allocations of property to the various MACRS classifications.
- Prepare a written report which includes project background information, methodology, fixed asset classifications and descriptions, allocation of project related fees and services, fixed asset classification spreadsheets segregating the assets into personal property (5 or 7 year tax life), land improvement property (15 year tax life), and nonresidential real property or commercial property (27.5 or 39 year tax life, respectively). The report will also include references to court cases, revenue rulings, tax citations and photographs supporting the position taken regarding the identification of personal property and land improvements assets for federal income tax purposes.