Cost segregation can save building owners thousands. (Insiders Outlook).
If you've answered "yes" to these questions, you could be missing a golden opportunity to save thousands of dollars that you would otherwise pay to the IRS. You may remember the method of depreciating your properties referred to as component depreciation. This was a method that allowed you to divide your property into components and depreciate them over much shorter lives than the building itself. At that time a building was depreciated over 19 years, therefore the window of potential revenue loss for the IRS wasn't that wide.
That all changed in 1986 when the IRS changed the depreciation rules. They prohibited the use of component depreciation and created a new method referred to as Modified Accelerated Cost Recovery System or MACRS. Under MACRS a residential building is to be depreciated over 27.5 years and a commercial building over 39 years (this was 31.5 years until 1993.)
Because of this longer depreciation period, the IRS prohibited you from breaking your property into its components. Because of this, you may think that the concept of component depreciation is history. Well, it's not.
This is primarily due to a tax case, Hospital Corp. of America, Inc. (HCA) vs. Commissioner (T.C. 21(1997)), which decided that it is possible for you to segregate your building into its parts and maximize your depreciation in the earlier years, when it is most useful. HCA built medical facilities and in doing so, took the position that they built more than just a building. They made land improvements, installed certain types of flooring and specialty wiring among other improvements. HCA depreciated these improvements over their shorter lives, as permitted under MACRS, which did not sit well with the IRS. On April 1, 1999, the chief counsel of the IRS issued a memorandum stating that the position taken by ECA was a valid position and "...the use of cost segregation studies must be specifically applied by the taxpayer". Then in August 1999, the IRS acquiesced.
Because of the 14-year absence in its use, many people may have forgotten the full benefits that can be gained by utilizing cost segregation...you may even be asking yourself exactly "what is this process that can save me money?" In short, a cost segregation study results in the re-allocation of your construction or acquisition costs between the cost of the building and the improvements made to the property, which qualify for shorter depreciable lives. A cost segregation study is usually performed by a CPA and/or a qualified appraiser or engineer.
Cost segregation studies are not only beneficial to newly constructed properties, but can also be applied to acquisitions or inherited properties. In fact, these studies can be applied to any property that has been recently acquired, constructed or inherited at any time since 1987.
The IRS does not allow you to amend tax returns in order to reap the benefit of depreciation you could have taken in the past years. Instead the IRS states that this is a change in accounting method and therefore a Form 3115 must be filed (which receives automatic approval by the IRS, therefore does not need their consent), and the retroactive adjustment is taken in the year of change. Until recently the retroactive adjustment was taken evenly over a four-year period.
For example, we recently did a study for a very large mix use property (700 residential units over commercial retail space), purchased in 1998 for $100 million. After completing the study we calculated that had the taxpayer applied the study at the time they acquired it, 1998, through 2001, they would have taken an additional $4 million in depreciation. Our client will get an additional $4 million tax deduction this year as a result of the study, saving them approximately $1.8 million in taxes this year. In addition they will continue to depreciate the property in accordance with the result of the study, thereby continuing to accelerate the depreciation for years to come.
All properties can benefit from a cost segregation study; however it is not always cost effective to do a study. The following is a partial list of the improvements which can be depreciated over shorter lives than the building, i.e.: five, seven or 15 years vs. 27.5 or 39 years, utilizing accelerated methods: Site utilities, landscaping, curbing and paving and fencing. As you can see by this partial listing every property would include some if not all of these improvements. The best properties or those that tend reap the greatest benefit are shopping centers, multi family garden apartment complexes, suburban office buildings and large flex industrial facilities. Just because your property does not fit into one of these descriptions, you should still go through the five steps indicated earlier in the article. This process should take little time and effort and should not cost you anything.
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|Title Annotation:||tax savings|
|Publication:||Real Estate Weekly|
|Article Type:||Brief Article|
|Date:||Sep 11, 2002|
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