Owners can benefit from cost segregation studies. (Insiders Outlook).

If you own retail property, a recent tax court decision now provides a proven method to add money to your bottom line. You do this by utilizing cost segregation techniques -- that is segregating the various building costs into separate categories as defined by the IRS.

Wait, it gets even better. This IRS decision also allows you to claim catch-up depreciation, too. This is the amount that you could have claimed in prior years, all the way back to 1987, and this entire amount can now be taken in a single year in accordance with Rev. Proc. 2002-19 released in March of this year. Prior to this issuance, catch-up depreciation had to be taken over a subsequent four-year period.

Many owners recall the pre-1986 days of using component cost depreciation to lower taxes. That technique was disallowed by the IRS as a result of the Tax Reform Act of 1986. A lack of IRS direction and guidance caused taxpayers to revert back to straight-line depreciation, and the TRA '86 had longer recovery periods, too. Other tax delaying techniques were still available, but there was simply too much uncertainty about the outcome of litigation should the IRS contest any studies. However, this all changed with the landmark Hospital Corporation of America Tax Court decision and the IRS's subsequent Letter Ruling 199921045, agreeing with the court that cost segregation studies are valid.

Essentially, cost segregation analysis allows an owner to depreciate certain types of building components and improvements over a shorter time period than the typical 39-years used for non-residential property or 31.5-years, if you have owned your retail center prior to May 13, 1993. Cost segregation entails a thorough estimate of the building's depreciable costs (direct and indirect), reconciling same with the tax return's depreciable basis, and then the segregating of such costs into shorter-lived asset categories that are differentiated between the realty and the personalty. Most owners and their accountants typically lump all costs together and simply depreciate this amount over a 31.5 or 39-year period. Provided that the owner intends to hold the property for five to six years, this would be a mistake, since it needlessly wastes a valuable tax benefit that provides real dollars to the bottom line.

Cost segregation is not just applicable to new construction or new acquisition. Regardless of the age of the property, the depreciation clock starts from zero whenever an acquisition is made. In short, if the property was acquired after 1987, it is a cost segregation candidate.

The tax savings can be significant. For most of our assignments, the fee paid to have a cost segregation study prepared generally ranges from $5,000 to $20,000. However, the estimated tax benefit of the study is at least eight times the fee that will be realized over a conservative hold period. Quite often, the fee is paid back in multiples from the first year's savings alone. For example, we prepared a cost segregation study on a retail center having a $3 million depreciable basis, which our client acquired in 1994. Using a 46% combined federal and state tax rate, the client realized an after-tax present value savings of $140,000 when compared to utilizing the 39-year approach.