Cost Segregation - Why isn t my CPA already doing this
Below is a MRR and PLR article in category Finance -> subcategory Real Estate.
Cost Segregation: Why Isn’t My CPA Already Doing This?
Introduction
Many commercial property owners miss out on substantial federal income tax savings because they aren’t using cost segregation?"a powerful tax tool?"even when they have professional accountants.
Why CPAs Might Not Be Utilizing Cost Segregation
Although most accountants know about cost segregation, they may hesitate to recommend it without a comprehensive analysis. The complexity of IRS-designated building components makes it challenging to identify every depreciable item. CPAs often suggest consulting a real estate specialist for an independent report to accurately assess depreciation.
Despite being underutilized, cost segregation is a well-supported method. The American Institute of Certified Public Accountants’ National Journal of Accountancy has published multiple articles endorsing it.
Understanding Cost Segregation
Cost segregation helps identify and value different property components, setting the right timeline for depreciation. Normally, depreciation spans up to 39 years, but with cost segregation, certain parts can depreciate over 5, 7, or 15 years. This accelerated depreciation reduces taxable income without affecting alternative minimum tax issues.
How Professionals Conduct Cost Segregation Studies
A cost segregation analysis starts by reviewing the property's cost basis?"covering construction, renovation, and repair costs. A technician visits the site to measure and assess property quality and condition. They then calculate the property's value based on standard pricing resources and local economic conditions.
The resulting study provides a detailed report that outlines the 5, 7, and 15-year property classifications eligible for short-life depreciation. Real estate appraisers or engineering firms typically perform these studies, often recommended by tax preparers due to the specialized knowledge required. IRS regulations define about 130 property categories eligible for shorter depreciation periods.
CPAs and Cost Segregation
Research indicates that cost segregation is used only 5% to 10% of the time. Many CPAs find cost segregation outside the usual scope of tax practice, yet those familiar with it highly recommend it.
Bill Bandy, a CPA from Blakely and Bandy in Houston, states that a well-prepared study is invaluable for accurately preparing depreciation schedules and reducing taxes. Recent tax regulation changes have made cost segregation even more appealing, allowing implementation years after purchasing a property.
The Mechanics of Cost Segregation
Typically, depreciation is split between land and long-life property?"27.5 years for apartments and 39 years for commercial properties. A cost segregation study can often allocate 20% to 40% of improvements to short-life categories.
For high-income owners, this can lower the effective federal tax rate from 35% to 15% by reallocating property basis to shorter depreciation lives. However, C corporations pay the same rate for both ordinary income and capital gains.
Potential Savings
One firm's client experienced a first-year savings payback ratio of 4:1, increasing to 20:1 over five years.
Who Conducts Cost Segregation Studies?
Appraisal and engineering firms, along with Big Four accounting firms and their spin-offs, are the primary providers of these studies. Some accounting firms offer the service but often outsource the preparation. As more providers enter the market, the cost of these studies varies widely.
Is Cost Segregation Right for All Properties?
Cost segregation is typically effective for properties with an improvement basis of $500,000 or more, especially those with significant site improvements like landscaping and parking.
It applies to properties across the U.S., including apartments, office spaces, retail, industrial sites, self-storage facilities, and specialized properties. CPA Sheldon J. Donner from Donner Weiser & Associates in Atlanta emphasizes that cost segregation is a conservative, cost-effective way to reduce taxes. Clients have been very satisfied with the outcomes.
When to Obtain a Cost Segregation Report
Jeff Harris, CFO of Boxer Properties, suggests obtaining a cost segregation study after acquiring or building an investment property. Properties purchased or constructed after 1986 can still benefit, as previously missed depreciation can be claimed without filing amended tax returns.
Conclusion
Cost segregation is a valuable tool for reducing federal income taxes, but it requires specialized knowledge often outside the scope of traditional accounting practices. By consulting with the right professionals, commercial property owners can make substantial savings.
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