This is the Time for Cost Segregation Studies

By Andrew Smith September 4, 2013

(The potential for significant tax savings)

This article was also published in the September 4, 2013 issue of New Hampshire Business Review.

I don’t think Billy Joel was thinking about Cost Segregation when he penned his 1986 hit “This is the Time,” but you certainly should be thinking about it as part of your tax deferral strategies for 2013.

Taxpayers with adjusted gross incomes in excess of $400,000 ($450,000 for MFJ) have seen their maximum federal tax rate increase from 35% to 39.6% in 2013.  Add to that the 3.8% Medicare Surtax on investment and passive income and some business owners could see as much as a 8.4% total increase in their tax rate, before factoring in the unfavorable impact of the renewed “Pease” Itemized Deduction Limitation.  For example, I met with a client two weeks ago to discuss his 2013 Tax Projections.  We are projecting a $1.5 Million decrease in income for this individual in 2013 but only a $15,000 decrease in his federal income tax liability!  With these changes, tax planning is more necessary than ever before, and cost segregation studies represent an excellent way to accelerate tax deductions.

A cost segregation study analyzes building costs and identifies specific components that qualify for shorter federal tax lives than the building as a whole.  The typical tax depreciation life for most buildings is 39 years (27.5 for Residential Real Estate), whereas many of the components identified thru a cost segregation study can be depreciated over 5, 7, or 15 years.  In addition to being depreciated over a shorter period of time, these components also may be eligible for accelerated depreciation methods, the Sec. 179 Expensing Election, and/or 50% Bonus Depreciation.  This increase in current depreciation reduces taxable income, lowers taxes, and therefore increases cash flow.

Cost segregation studies most commonly are done when taxpayers either acquire or construct new property.  The study will determine the proper depreciable lives for the various fixed assets and allow them to begin depreciating in the most optimal manner.  However, cost segregation studies also may be done retroactively.  This allows the entire cumulative benefit for prior years (the optimized deductions vs. the actual deductions) to be recouped entirely in the year of the study thru a change in accounting method.

Taxpayers who have acquired or remodeled a piece of real estate in the past 10 years may want to consider a retroactive study, reaping the benefit in 2013.  Savvy taxpayers working with their tax advisors can also use cost segregation studies in conjunction with the new 263a Repair and Maintenance Regulations (described in a previous BNN article) to even further reduce their tax liabilities.

Cost segregation studies are accepted by the IRS and if done properly do not increase your risk of examination.  The cost of the study, as well as the potential tax savings, varies based on the building use as well as the costs incurred.  If you or your business have incurred over $1 Million in construction or acquisition costs over the past 10 years, please inquire with your tax advisor about the possibility of a cost segregation study or contact Andy Smith directly.  Andy has over 15 years of experience working with clients and performing cost segregation studies.