The Cost Segregation Study: Understanding Your Estimate of Benefits
Is doing a cost segregation study going to be worth your while? Is it really worth the time? The fee? The logistics? While the Capstan team is likely to respond with an emphatic “yes” to all of the above, we understand that in order to make an informed decision, prospective clients need to fully understand the potential benefits of the study. Capstan routinely prepares a no-cost Estimate of Benefits (EOB) report that demonstrates these benefits in a straightforward manner. But how to interpret this useful document?
In order to prepare the EOB, Capstan will request data related to the property’s acquisition, construction, or renovation, that may include cost documentation, AIAs, and property depreciation schedules as appropriate. Capstan will then assess the data and, utilizing our average results for similar properties, will estimate what portion of the assets represented by the original purchase price may be reallocated to shorter-lived 5, 7 and 15-year MACRS lives.
Our example considers a shopping center, originally purchased for $10,500,000. In the example, 10.5% of the property’s basis is estimated to qualify as 5-year MACRS property, resulting in the allocation of $1,100,000 worth of assets as 5-year MACRS life. Similarly, 9.5% of the basis is estimated to qualify as land improvements, 15-year MACRS property, resulting in the allocation of $1,000,000 worth of assets as 15-year MACRS life.
Page 2 of the EOB report demonstrates how depreciation would be calculated had the cost segregation study been completed in the year the property was acquired. The pages also illustrate the greater amount of depreciation attainable through the use of cost segregation, in contrast with the lesser amount that would be attained if the entire building was depreciated using a 39-year class life. The “Total” column represents how much depreciation you could take using cost segregation. Subtracting the “Current Depreciation” amount from the amount in the “Total” column will result in the additional depreciation expense (“Add’l Deductions”) that you may be eligible to deduct on your tax return. The column labeled “Add’l Cash Flow” represents the tax benefit of the additional depreciation expense, using a combined federal and state tax rate of 40%.
One powerful feature of the cost segregation study is that the depreciation benefit accrued is retroactive to the year of acquisition. This allows the taxpayer to deduct all of the additional depreciation that would have been allowed in prior years in one massive “catch-up” amount when the study finally is performed. In our example, if a cost segregation study is performed in 2017 for a property purchased in 2012, the catch-up amount, or the 481(a) adjustment, is a depreciation expense deduction of $1,185,201. This represents the additional depreciation for the prior five years, from 2012 to 2016. In the current year (2017), the additional depreciation expense is $85,788. Allowing the taxpayer to deduct the depreciation for all six years simultaneously has a significant impact, bringing the total additional depreciation to $1,270,989. When multiplied by a 40% tax rate, the resulting additional estimated cash flow in Year One after the performance of the study is $508,396 (as seen on Page 1).
The depreciation table continues to calculate the differences in depreciation expense under cost segregation through the year 2052. Beginning in the year 2027, the depreciation yielded via cost segregation is less than the depreciation accrued under a 39-year life, and the cumulative benefit of cost segregation begins to reduce. However, due to the time value of money, the reductions that are ten, twenty or thirty years out are much reduced. Capstan can tailor the EOB to each client’s situation, and can further customize the report by using the client’s tax rate and discount rate.
After reviewing the EOB, the client can decide if they wish to engage Capstan to perform a cost segregation study. By providing a clear picture of short and long-term potential benefits, Capstan offers clients the information required to make the best possible decision. If we can provide you with a no-cost, no-commitment EOB, please let us know – we’d be honored to be a part of your decision-making process.