Much faster depreciation on buildings?

Divide and conquer: How cost segregation surveys can pump up depreciation deductions

Many businesses have learned a long time ago that separately stating each charge on a bill that you send out can help increase the amount you can ask for from the customer. Restaurants do it, so do building contractors, hospitals and autobody shops. A growing number of taxpayers, too, are discovering the benefits of separately stating tax items – this time in the form of a process called “cost segregation.”

Cost segregation

“Cost segregation” allows a business to separate its real estate tax depreciation deductions on its buildings from tax depreciation taken on the personal property that is connected with the real estate, as well as for depreciable land improvements.

Since the cost of the personal property items, as well as certain improvements, can be written off much faster than the cost of the building itself, significant tax savings can occur.

Example. Say the building that you just had constructed for your business cost you $3 million. Nonresidential real property is depreciated using the straight-line method over an assumed 39 year life. That’s a $76,923 depreciation deduction each year. However, a careful look using cost segregation could reveal that up to $500,000 of that cost charged by the builder was actually to pay for specialized lighting, removable carpeting, partitions, kitchen equipment, decorative elements and the like. That property, although normally associated with a building, is considered personal property by the IRS and can be depreciated over only a 5 year assumed lifespan. What’s more, first year depreciation on that property can be accelerated and could qualify for the 50 percent “bonus” depreciation. Bottom line: Your business gets over $100,000 of additional depreciation immediately!

“Catch-up” deductions

This new technique is not limited to newly constructed or purchased property. If you started to use a building in your business after 1986 without allocating any costs to personal property, you qualify.

Your tax advisor can apply to the IRS for permission to change your accounting for the building, which in turn will allow you to immediately deduct—all in one year—as a “negative adjustment” all the extra depreciation that you have missed out on.

Example. You bought your factory in 1995, but did no cost segregation at that time because it wasn’t commonplace then. A cost segregation study now, however, allocates $1 million of the original cost to 7-year personal property. On your 2003 tax return, you could be entitled to an $800,000 “catch-up” depreciation deduction equal to the difference between the $1 million cost and the approximately $200,000 already taken on that property.

Not for amateurs

Cost segregation studies that are acceptable to the IRS require a great deal of expertise. This office can do the necessary homework, and find the architects or construction engineers who specialize in these studies. Depending on the type of building and the skill and aggressiveness of the firm conducting a cost segregation study, between 15 to 60 percent of a building’s cost is typically allocated to personal property and separately depreciable land improvements – a substantial incentive to investigate this opportunity.