Cost Segregation Studies can Save Money

The tax code can seem like a large, daunting, unfriendly thing. But facilities managers who are willing to explore the code’s nuances could find savings that dramatically affect their companies’ bottom lines.

According to the tax code, buildings depreciate over the course of 39 years. That means you can deduct the money you spent on construction costs—but only very slowly. Other kinds of assets can be depreciated much more quickly, however, or even expensed in the same year they are purchased.

Cost segregation professionals look for aspects of your construction or remodeling projects in which the depreciation can be accelerated, such as carpeting and decorative light fixtures. Reclassifying those assets allows your company to deduct more expenses in the short-run and reduce its tax liability.
    
On most projects, cost segregation professionals can reclassify about 30 percent of construction costs into categories in which the assets depreciate more quickly. In a retail environment, for example, not only can items like cash registers and decorative fixtures be reclassified, but also the outlets, junction boxes, circuit breakers and panel boards that power those items.

The studies can also be labor-intensive and expensive, however. A good rule of thumb is that if your construction or remodeling project expenses amount to $1 million or more, a cost segregation study is likely to save you money, according to Grant Keppel, author of Real Estate Cost Segregation: A Practitioner’s Guide (Thomson RIA).

“It comes down to cost versus benefit,” he says. “Above that $1 million mark, you’ll probably get $10 in tax benefits for every dollar you spend on the study. But once you start creeping below that level, it makes the benefits diminish.”

If you’re not sure a cost segregation study would benefit your company, you can request an estimate of reclassification as part of the proposals you submit to cost segregation firms. With a cursory review of the specifics of your project, a cost segregation expert should be able to produce a fairly accurate estimate.

The adage about getting what you pay for is just as applicable to cost segregation studies as to the labor that went into constructing the building in the first place. There are several methods for performing cost segregation studies, and the one that demands the most time and expertise is also the one most favored by the Internal Revenue Service. That’s a detailed engineering analysis, where cost segregation firms review structural, mechanical, architectural, site and electrical plans, making precise notes about the assets they reclassify. Other methods, such as statistical sampling, can work for chain stores with cookie cutter locations, but those methods are less exact.     

“In most cases, the IRS prefers a detailed engineering study because those studies show that we’ve gone in detail over the specifications, the cost information, the engineering applications, as well as the proper tax and accounting applications,” says George Hamilton, president of the American Society of Cost Segregation Professionals, based in Washington, D.C. “In the event of an audit, we know this is a system that the IRS feels comfortable with.”

A couple of other things to consider: Cost segregation studies only make sense for profitable businesses. If you’re not turning a profit, you don’t have a tax bill, and thus no need for deductions. However, a 2008 change to the tax code means that businesses that lose money this year can apply tax deductions retroactively to any year in the last five in which it owed money.

Cost segregation studies could save your company tens of thousands of dollars in taxes. Who says the tax code isn’t friendly?