Your Top 10 Cost Segregation Questions: Answered

May 19, 2023

We talk about Cost Segregation a lot.  And we find that the same questions come up time and time again.  Here’s a compilation of answers to your most common queries – plus links to additional Capstan resources for learning more.   

1. What Exactly is a Cost Segregation Study?  

Any given property contains a multitude of different assets, and each of them may be expected to have a different useful life.  For example, you can confidently expect ceramic flooring to last a lot longer than say, carpet tile.  Tax law provides guidance that can indicate how long different assets might last, using the Modified Asset Cost Recovery System (MACRS). The default MACRS class-life for most capital assets is 39 years, or 27.5 years for assets in a multifamily property.  That means that if no cost segregation study is performed, assets will typically be depreciated over 39 years for commercial property or 27.5 years for residential.  Now that makes sense for ceramic flooring, but not for carpet tile.  Why should carpet tile just sit on the books, being depreciated over 39 long years?   

In a cost segregation study, engineers identify and quantify building assets, and then assign each asset a cost.  These costs are then segregated into different categories according to their depreciable asset class lives. Base building or “shell” assets remain 39-year assets, but many assets can be moved into shorter-lived class lives:    

    • 5-Year Assets: carpet tile, counters, break room sinks, cabinetry and decorative moldings, specialty lighting, dedicated outlets, fire extinguishers and more  
    • 7-Year Assets: office furniture  
    • 15-Year Assets: land improvements like drainage pipes, parking lots, landscaping, outdoor swimming pools, protective bollards, sidewalks, and more 

By segregating these assets into shorter-lived categories, they can be depreciated more quickly, resulting in tax savings and increased cash flow.  Feel free to review a variety of examples to get a sense of the potential benefit.   

2. Can I Do My Own Cost Segregation Study? Is an Engineer Really Necessary?  

Since the concept of cost segregation is fairly easy to grasp, many people think that performing a cost segregation study must be fairly easy as well.   Actually, performing a quality cost segregation study is no simple feat, and requires the skills and experience of a trained engineer.

Engineers must draw on their knowledge of construction methods and related costs as they meticulously work their way through a project site, laboring to account for every possible asset. During the site visit, engineers will perform a forensic analysis of the property’s unique details. Then assets will be “brokenout,” assigned costs, and finally placed in the appropriate classlife category. Study results must then be analyzed from tax and technical perspectives, to ensure complete accuracy and compliance with IRSregulations.

In fact, the IRS’ Cost Segregation Audit Techniques Guide lists 13 “Principal Elements of a Cost Segregation Study.” The very first element is “Preparation by an Individual with Expertise and Experience,” and the Guide explicitly states that: “… a study by a construction engineer is more reliable than one conducted by someone with no engineering or construction background.”

In short, studies should be performed by experienced engineers who can provide reports that maximize savings while remaining defensible in the unlikely event of an audit.

3. Can My CPA Firm Do the Cost Segregation Study?

In some situations, your CPA firm may indeed be able to perform a Cost Segregation Study. These firms are
generally very large, with engineers right on staff. Most firms don’t have the resources to manage that, and often
choose to work with a third-party Cost Segregation Provider. It’s important to choose an independent third-
party that both the CPA and the client feel is trustworthy, so be sure to do your homework before selecting a provider.

CHOOSING A COST SEG PROVIDER

You want to be certain that you and your clients are in the best possible hands. To select a quality cost-segregation provider, consider these questions:

    • How many studies have been performed by your team?
    • Will my study be performed by a degreed engineer? Do you have ASCSP-Certified team members on staff?
    • Do you provide a complimentary Estimate of Benefits?
    • Is a site visit performed?
    • What methodology is used to create the report? What kind of technical/tax review process is involved?
    • How frequently will you communicate with me/my client? Can you tailor your level of engagement to our preferences?
    • Will you stand behind your work product in the unlikely event of an audit?
    • Can you help us craft a comprehensive tax plan that will serve us now and in the future?
    • If legislation changes create new savings opportunities, will you revisit my report?

4. Is Cost Segregation Really Worth It? I Found this
Online Calculator That Said…

Cost Segregation can certainly be “worth it” in terms of return on investment. Cost segregation fees vary, and are generally commensurate with a project’s scope, size, and complexity. The usual return on investment for a cost segregation report is well over 10 to 1.

Cost Segregation bestows benefits beyond accelerated depreciation. The study can provide the data needed to support a myriad of other tax strategies, preparing you for savings in the future.

Additionally, the right provider will stay up to date on current legislation. If new savings opportunities become available, your Cost Segregation study can be revisited, adding even more return to your modest investment.

Because cost segregation is so nuanced, and the facts and circumstances of every project vary, online calculators provide a general estimate at best. Take those results with a grain of salt. A quality cost segregation provider will provide you with a complimentary Estimate of Benefits after reviewing your specific fact pattern.

5. What Kinds of Commercial Real Estate Can Cost Segregation Be Performed On?

Properties like office buildings, hotels, and retail spaces often come to mind when people think of cost segregation, but it can be performed on any type of commercial real estate. In fact, some of the hottest property types for cost seg today include:

Cost segregation can even be performed on non-profit tenants in otherwise for-profit spaces, a trend we’re seeing quite a bit of lately.

6. Does Cost Segregation Create New Deductions?

Moving assets into shorter-lived categories doesn’t magically generate new deductions. It just accelerates the deductions so the taxpayer gets the depreciation benefit sooner, taking advantage of the time-value of money.

7. When is the Best Time to Perform a Cost Segregation Study?

Ideally, it’s best to perform a cost segregation study immediately after a property is placed-in-service, to maximize savings from day one. However, if that was not possible, the IRS allows the benefits from previous years to be claimed using a “look-back” cost segregation study. By reclassifying assets to their correct lives, taxpayers can “catch-up” on all the depreciation they would have gotten had the study been performed on day one. Look-back studies require the
use of Form 3115.

8. Is Cost Segregation Only Useful for Newly Constructed or Acquired Properties? Can I Use Cost Segregation in a Renovation Scenario?

It’s true that Cost Segregation is a great tax strategy to use on newly constructed or acquired properties, or those  constructed or acquired several years ago.

However, impending renovations are also an excellent cost seg trigger. It might seem counterintuitive to perform a detailed study of assets that you plan to dispose of. Why quantify assets that are on their way out? The answer is simple — if these assets are quantified through a cost segregation study before they are retired, you can use that data to take advantage of a strategy called Partial Asset Disposition (PAD) Election PAD Elections permits a taxpayer to write off the remaining depreciable basis of an asset that was disposed of in the year it was removed. This can be an incredible tax-savings strategy, but requires a complete record of the assets in question.

Cost segregation is useful throughout the life cycle of real estate.

9. What is Bonus Depreciation? How is it Connected to Cost Segregation?

Bonus depreciation permits the additional write-off of an eligible asset’s value in addition to standard depreciation. New assets with class lives of 20-years or less are eligible for this “bonus,” which significantly boosts tax savings. The Tax Cuts for Jobs Act (TCJA) allows bonus depreciation to be taken on used assets placed-in-service on or after 9/28/2017. Cost segregation is an effective tool used to determine and document which assets have eligible class lives and are therefore eligible for this powerful incentive..

The bonus depreciation rate is 100% for eligible assets placed-in-service between 9/28/2017 and 12/31/2022.  The rate has decreased to 80% for projects placed-in-service in 2023, and will continue to decline by 20% annually through 2026.

Cost segregation studies still bring great benefit, even at lower bonus rates.

 

10. What is Qualified Improvement Property (QIP)?  How is it Connected to Cost Segregation?

Qualified Improvement Property (QIP) is defined as any improvement to an interior portion of a building which is nonresidential real property if the improvement is placed-in-service after the date the building was first placed-in-service by any taxpayer.  (If you want more clarity on this definition, read our blog that breaks it down piece by piece.)  The CARES Act of 2020 assigned QIP a 15-year recovery period.  By assigning QIP a class-life of less than 20 years, the CARES Act made QIP bonus-eligible, in a huge boon for taxpayers.      

A cost segregation study is the key to this incentive as well, as it provides the comprehensive data required to categorize and assign cost values to QIP assets.     

We’ve covered our answers to your most common questions, but we’re here to help with the uncommon ones too. 
Let’s be in touch.    

Cost segregation studies still bring great benefit, even at lower bonus rates.  

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