Legislation Increases Benefits of Cost Segregation Studies

Recent legislation has put a renewed emphasis on the benefits of cost segregation studies. Companies are often interested in ways to reduce cash outlays. A cost segregation study is a study of depreciable property to accelerate deductions based on the reclassification of property from real to personal, generally. Any business that has built a new facility, acquired real estate, or completed a remodeling/renovation project can benefit from a cost segregation study.

Real property generally has recovery periods of 39 years and is depreciated using a straight line method. By employing a cost segregation study, a significant portion of the property may be reclassified to a shorter life category; e.g. 5, 7 or 15 years and/or may qualify for bonus depreciation of 50% or 100% in the first year. This results in the following benefits for a company:

  • Maximization of federal tax depreciation
  • Identification of assets for future retirement
  • Improved cash flow
  • Reduction of real estate transfer taxes
  • A basis for your fixed asset system
  • Reduction of real estate property taxes

New Legislation

New legislation has made cost segregation studies more appealing than they have been in recent years. In particular, the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 has created more benefits pertaining to cost segregation studies. Under Sec. 168(k) bonus depreciation has been increased to 100% for certain property acquired after 9/8/2010 and before 1/1/2012. Prior to 2010, bonus depreciation was 50%. Also, qualifying property is exempt from the alternative minimum tax depreciation adjustment. The requirements for qualifying property are outlined in the Act. The 100% bonus depreciation opportunity provides a significant benefit for businesses in 2011. This has driven tremendous interest in cost segregation studies to maximize the opportunity provided by this incentive.

In addition, the Small Business Jobs Act (SBJA) of 2010, which applies to property placed in service in years beginning after 2009, provides a greater benefit with respect to Sec. 179 deductions. Prior to SBJA, deductible Sec. 179 expenses could not exceed $250,000. In addition, the maximum amount had to be phased out by the amount by which the cost of the Sec. 179 property placed in service exceeded $800,000. Under SBJA, deductible Sec. 179 expenses cannot exceed $500,000 and the phase-out starts when the property exceeds $2 million.

SBJA has temporarily expanded the definition of property qualifying for a Sec. 179 deduction to include qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property. These provisions apply to property placed in service in years beginning in 2010 and 2011.

Other Opportunities

Along with the opportunities created by the new tax legislation, there are other situations where a cost segregation study can be beneficial, including identification of the following types of expenditures:

  • Repairs. Expenditures that are often capitalized, such as building improvements may qualify as repairs and provide a deduction benefit.
  • Research and experimental expenditures. Costs involving engineering or a technical field may be identified during a cost segregation study and may qualify as research and experimentation expenses and would, therefore, be deductible.
  • Section 179D. Provides for an energy efficient commercial buildings deduction which may also be captured through a cost segregation study.

The following case studies show the substantial benefits that can be realized from a cost segregation study.

Case Studies

1) We completed a cost segregation study for an international manufacturing client that built an office, manufacturing, and warehouse facility for approximately $12,000,000. The purpose of the study was to identify, for corporate tax purposes, the cost of certain items of tangible property in accordance with Internal Revenue Code (IRC) Section 1245 and Section 1250. Our study included real estate comprising the building and land improvements; and specific equipment.

The results of our cost segregation study are summarized as follows:

  • Present Value Benefit $382,000
  • 1st Year Tax Benefit $96,000
  • 1st Through 5th Year Tax Benefit $455,000

2) Our client purchased a 19,000 square foot fine dining restaurant for $8,000,000, excluding land value. The purpose of the study was to determine, for corporate tax purposes, the fair market value of real property and certain items of tangible property under Section 1245. Our study included real estate comprising land improvements and buildings; and specific equipment.

The results of our cost segregation study are summarized as follows:

  • Present Value Benefit $462,000
  • 1st Year Tax Benefit $142,000
  • 1st Through 5th Year Tax Benefit $606,000

From a valuation perspective, there are different considerations depending on whether the property is newly constructed or is an existing property. For an existing building it is necessary to determine how much relates to the building itself and how much should be allocated to the other pieces of property. An important part of the analysis is determining whether there has been a reduction in value due to use/wear or tear. For more information, contact your VRC representative.