Transcript Cost Segregation Analysis

“Understanding
Cost Segregation Studies”
Presented by:
Cathy A. Harris, CPA
Director, Cost Segregation Group
What is a Cost Segregation Study?
 A cost segregation study (CSS) is a systematic
engineering-based analysis and classification of
all capital expenditures associated with a newly
constructed, renovated, recently purchased or
existing property.
CSS Goal
 The goal of a CSS is to identify assets as either
real or personal property and to separate the
capital expenditures into the most optimum
MACRS asset classifications allowed by IRS code,
revenue rulings and existing case law.
Why is a Cost Segregation Study
a Good Idea?
 A properly completed Cost Segregation Study
will:
 Maximize tax deferrals through accelerated
depreciation
 Increase cash flow through a decrease in tax
exposure – potential for a big “catch-up”
 Minimize taxable gains on the sale of property
What Type of Owners Benefit?
 Taxpayers with a commercial property having
depreciable basis of $750,000 or greater.
 Taxpayers who have constructed, purchased, expanded
or renovated commercial properties since 1987.
 Lessees and lessors who have made leasehold
improvements of $750,000 or greater.
 Owners of properties about to be sold or who have sold
property in recent years.
Primary Property
Recovery Periods
Component
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Building
Land Improvements
Furn, Fixt. & Equip.
FF&E, Retail & Service
Information Systems
Recovery Period
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27.5 or 39 years
15 years
7 years
5 years
5 years
Average Value Misclassified
by Property Type
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Manufacturing
Hotels
Apartments
Restaurants
Office Buildings
Research & Development
Hospitals
Tenant Improvements
Retail
Grocery Stores
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20%
15%
20%
10%
10%
20%
20%
15%
15%
15%
-
60%
40%
50%
40%
40%
50%
50%
50%
40%
50%
Examples of Reallocated
Personal Property
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Carpeting
Wallcoverings
Cabinetry
Specialty lighting
Specialty electric and plumbing
Built-in shelving
Loading dock equipment
Examples of Reallocated
Land Improvements
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Asphalt
Concrete
Parking lot lighting
Curb and gutters
Signage
Landscaping
Benefits of a Cost
Segregation Study
 The present value of income tax savings, at 7%
interest rate, for each $100,000 in property
identified as personal property versus
nonresidential real property with a 39 year life:
 5 Year property - $17,200
 7 Year property - $15,800
 15 Year property - $9,600
*
Assumes 35% Federal Income Tax Rate
Average NPV Savings
Building Type
Ave. First Year
Savings/
$1million of
Depreciable
Property
Avg. NPV Savings /
$1million
Of Depreciable
Property
Apartments
$
10,000
$
36,000
Hotels
$
20,000
$
64,000
Office Buildings
$
8,000
$
39,000
Office Parks
$
7,500
$
35,000
High-rise Office Buildings
$
6,000
$
24,000
Shopping Centers
$
10,000
$
44,000
Flex Buildings
$
9,000
$
39,000
Office-Warehouses
$
7,000
$
34,000
Manufacturing
$
7,500
$
34,000
Auto Dealerships
$
11,000
$
51,000
Catch-Up Depreciation
 For existing properties that are not optimally
classified, the IRS provides an automatic
consent procedure to make changes on a
“catch-up” basis.
 Depreciation differences between current and
optimum property classifications are currently
allowed to be fully expensed in the year of
change.
Year of Sale Study
 Catch-up depreciation taken at ordinary tax
rates (up to 35% federal rate).
 Additional gain on sale recognized at capital gain
rates (15% federal rate).
 Up to 20% tax savings on additional
depreciation taken in the year of sale.
Recent Developments Relating to
Depreciable Property
 Bonus Depreciation is back for 2008 and 2009!!!
 For assets contracted and placed in service between
January 1, 2008 and December 31, 2009.
 Enhanced Small Business Expensing
 Deduct capital expenditures up to $250,000 phased
out after $800,000 in additions.
 Increase extended from 2008 through 2009.
Recent Developments Relating to
Depreciable Property
 5 year NOL carryback for small businesses.
 Expenditures related to tangible property:
Current deduction v. capital expenditure.
 Improvements to restore property to former working
condition or to keep property in ordinary efficient
operating condition may be currently expensed.
 Improvements which add to the value or prolong the
useful life of the property must be capitalized.
IRS Cost Segregation
Audit Technique Guide
• This guide was developed to assist IRS agents in the
examination of cost segregation studies. Latest
update was December 2007.
• It identifies cost segregation methodologies that the
IRS believes are valid and those which require
additional scrutiny.
• The guide identifies the attributes of what the Service
believes is a quality cost segregation study and
report.
The Process
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Based on preliminary information given, we use our
extensive database and estimate the expected tax
benefit.
A fixed fee proposal is offered.
A site visit is made, and the data is processed.
Client is under no obligation to pay unless they receive
a net benefit from the study.
Average turn around is 30 to 60 days.
Steps in a Cost Segregation Study
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Perform on-site property tour to collect data.
Process detailed information from property tour, site
map, blueprints and specifications.
Prepare itemized list of all property components.
Compute actual or estimated acquisition and
installation costs for each identified component.
Allocate indirect costs to appropriate property
components.
Research applicable IRS code, regulations and case
law.
Determine appropriate depreciable life for each
property component.
Prepare and present final report.
Deliverable
 Cost Segregation Report
Preparer Information
Project Background Information.
Cost Segregation Methodology.
Asset Classification Summary.
Federal Tax Classifications.
Federal Tax Classifications Support.
Project Related Fees and Service.
Exhibit 1 - Federal Income Tax - MACRS listing of
assets and associated class lives.
 Exhibit 2 – Photographs.
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Shopping Center Example
 Purchase Price
$3,700,000
 NPV Tax Savings
$193,000
Allocation
Building 67%
Land
Improvements
15%
Personal
Property 18%
Hotel Example
 Purchase Price
$3,300,000
 NPV Tax Savings
$178,000
Allocation
Building 68%
Land
Improvements
7%
Personal
Property 25%
Apartments Example
 Purchase Price $22,000,000
 NPV Tax Savings $969,000
Allocation
Building 55 %
Land
Improvements
27%
Personal
Property 18%
Example Catch-up Study
 Shopping Center capitalized building at
$1,517,000 between 1990 and 2005.
 Reclassified $300,000 to 5 year assets.
 Reclassified $249,000 to 15 year assets.
 Catch-up Section 481 Adjustment through 2005
was $281,000. Adjusted on the 2006 tax return.
 Savings in 2006 to owners exceeding
$100,000.
Year of Sale Benefit Example
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Purchase Price: $11,400,000
Sales Price: $25,000,000
Year of Sale Tax w/o CSS: $2,600,000
Year of Sale Tax w/ CSS: $2,300,000
Tax Savings exceeding: $330,000
Benefit Over Price
(Return on Investment)
Property Type
ROI
Apartment
4000%
Auto Dealership
3500%
Hotel
1800%
Manufacturing
2000%
Office Building
3750%
Office Park
5000%
Retail Store
2000%
Shopping Center
2500%
Office-Warehouse
1750%
Flex Building
1250%
High Rise Building
6000%
Storage Facility
1250%
Why use The Cost Segregation Group?
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Experience providing studies since 1998.
Billions of dollars in real estate segregated.
Engineers and CPAs perform studies.
Senior member of the ASCSP on staff.
100% IRS audit success.
Authors of CCH’s Practical Guide to Cost
Segregation.
Contact Us
 Visit our website:
www.costsegregationgroup.com
The Cost Segregation Group
Cathy Harris, Director
[email protected]
(757) 533-4118