Heidi Henderson is the Executive Vice President of Engineered Tax Services.
1. What is Cost Segregation?
Cost Segregation is the process of identifying personal property vs. real property, and individual building components for tax purposes, rather than treating a building purchase as one large asset. This determination allows a property owner to depreciate their assets over the useful life of each asset instead of assuming that the entire purchase amount applies to one long-term (39-year) asset.
2. Does my property qualify
All investment properties, including self-storage properties qualify for cost segregation. When a cost segregation study is applied, you are telling the IRS that you are simply choosing one acceptable method for depreciation (MACRS*) vs. another approved depreciation method (straight-line). Both are acceptable, however MACRS requires an analysis to identify the value of each individual asset you own, rather than looking at your property as one large asset.
3. When does it make sense to do a Cost Segregation study?
Cost Segregation can be applied to a newly purchased building, a newly constructed building, or a building you have owned for around 15 years or less. If the property is not fully depreciated (39 years is the length of normal depreciation), then there is an opportunity to change the method with cost segregation. Although any property can be depreciated under MACRS, the
costs of performing a cost segregation study may outweigh the benefits if the property was acquired for less than approximately $300,000.
4. What items are reclassified via Cost Segregation?
Under straight-line depreciation a property’s total cost (less an allocation for land), is depreciated evenly over 39 years. Under MACRS the assets are identified and reclassified in 5-year, 15-year, and 39-year class lives depending on the IRS determination of its actual useful life. And whether the assets are used for your business use, or the basic function of the buildings use as a structure. Examples of 39-year property include; windows, walls, doors, roof, HVAC systems, plumbing, and electrical. Examples of 15-year property include exterior improvements such as; fencing, exterior signage, asphalt, curbs, landscaping, and exterior lighting. And examples of 5-year property are; carpet, appliances, specialty lighting, woodwork, unit partitions, individual unit locks and security, and business specific heating and ventilation systems.
5. Does the type of property affect the tax savings?
Some property types will have a higher reallocation percentage than others. Interior, climate controlled self-storage properties will see a higher amount than a shed-row or boat and RV storage type. The allocations are based on actual assets and values or each of the components within the property.
6. What information is required to do a Cost Segregation study?
Surprisingly, the information required to perform the study is limited. For a recent purchase, the closing statement or HUD is the only requirement. Blueprints are helpful but not necessary. New Construction projects require cost breakdowns and total costs for construction and development, but individual invoices are not required.
7. How do I choose a Cost Segregation provider?
Choosing a reputable firm is a vital to ensuring that every aspect of the IRS requirements are met, and in the case of an audit the report is upheld without disallowances or associated interest and penalties. The IRS Audit Technique Guidelines dictate that a physical site visit is performed, the analysis is performed by a professional with cost-accounting or engineering expertise, and the method of determining asset value is an approved methodology. Make sure that audit defense is included in your study, and that the final report offers complete detail over every aspect of your property. Choosing a low-cost provide may be tempting, but the ultimate savings, detail and support of a reputable provider will far outweigh any additional costs. And finally, ask for references!
8. Will I get audited if I do a Cost Segregation study?
Cost Segregation is not a “trigger” for audit. The IRS issued automatic consent for deprecation whether applying a change from straight-line to MACRS at the time of purchase or retroactive for a property you bought 10 years ago. This means that taxpayers are allowed to make this change with the approved forms offered by reputable cost segregation firms. However, in the rare case of an IRS review, rest assured that a detail report with the proper IRS approved methods and audit support will affectively defend your tax filing position.
9. How much does a Cost Segregation Study cost?
The cost is usually based upon the type and use of the building, size, and location of the property. Beware of cost segregation providers who charge a percentage of the tax savings. The tax savings is relative to the entity type, number of owners, the year of acquisition and other factors, so the actual cash benefit can vary. Most providers will offer a quote along with projected tax savings, so you and your CPA have the information necessary to make an educated decision.
10. How much will a Cost Segregation study save me?
The tax savings realized with a cost segregation can vary depending on the type of building, your total acquisition cost, and length of ownership. Self-storage properties vary in type and size and may see reclassification percentages from 15% to as high as 40%. Request a detailed benefit analysis from a qualified and experienced firm who has a history with self-storage properties.
11. What does the Tax Cuts & Jobs Act (TCJA) passed in December 2017 mean for my tax return?
The Trump administration passed the TCJA which is the largest tax reform bill passed in over 30 years. There are significant changes that offer tax cuts for real estate investors. The largest change being the adoption of 100% bonus depreciation for tangible personal property acquired after September 27, 2017. Tangible personal property is defined as assets with a useful life of 5, 7 or 15 years. Therefore, when cost segregation is performed to identify the personal property
(5, 7 15-year property) apart from real property (39-year assets), it allows the property owner to capture bonus depreciation on those reclassified property and immediately expense the entire value in the year purchased!
*MACRS: Modified Accelerated Class Recovery System