The goal of a Cost Segregation Study is to identify building costs that have been traditionally depreciated 39 years and to re-allocate a significant portion of these costs to a shorter, accelerated method of depreciation. Additionally, they can be used to identifying improvements that may qualify for the 50% bonus depreciation and allocating hard and soft costs to these improvements.
Construction-related costs, which may account for as much as 75 to 90 percent of the overall project cost, are usually lumped together as real property with a depreciable life of 39 years. When segregating the costs of a construction project, it is easy to properly identify costs of equipment, furniture and fixtures, and computer equipment that can be depreciated over 5 and 7 years for tax purposes.
Benefit vs. Costs
Reclassification of costs from real property to personal property may: - Reduce tax lives from 39 years to 5 to 7 for assets such as such as removable carpeting attached with latex adhesives, signage, movable and removable partitions, cabinets and shelves, decorative millwork, window treatments, interior ornamentation, certain electrical and plumbing equipment necessary for the operation of specialized equipment such as computer rooms (rather than for overall building maintenance and operation) or lighting fixtures that are used for decoration or plant growth.
- Identify leasehold improvements that qualify for 50% bonus depreciation. These are improvements that are not for the cost of building enlargements, elevators or escalators, structural components benefiting common areas, or a building’s internal structural framework.
Structural components for these purposes are defined as load-bearing internal walls and any other internal structural supports, including the columns, girders, beams, trusses, spandrels and all other materials that are essential to the stability of the building.
Generally 10%-25% of the total cost may qualify for reallocation of costs into shorter tax lives. In most cases, tax saving for the first year will greatly exceed the cost of doing the study.
Candidates for Cost Segregation Studies
Includes: - Commercial properties with construction cost or purchase price over $1million.
- New construction or remodels/ rehabilitations after 1986
- Lessees with leasehold improvements
- Improvements with special equipments such as a computer room, a technology demonstration room, or a special lab.
Properties with cost lower than $1million, or planned to be sold in 2 years are not good candidates for a cost segregation study.
Timing of Cost Segregation Study
The best time to have a study completed is for the year the building or improvements are placed in service. During the process, considerable amounts of design or architect fees may be appropriately identified with certain equipments layout, non-structural improvements and be classified as properties of shorter lives rather than be lumped together and allocated to building. Specific identification is important since the IRS does not allow a simple percentage method for breaking out construction costs.
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