Cost segregation is a powerful way to cut your tax liability and boost your personal or business cash flow.
If you have purchased or remodeled any residential rental or business real estate property in the recent past, or you’re planning to, you’ll want to consider a cost segregation study to find ways to minimize your tax liability and keep more dollars in your business when it comes to depreciating that property.
Kami Elhert leads this discussion between Ted Zamerski, CFA, CPA/PFS, and Gregg Bell, CGC, during which they review:
- What cost segregation is;
- The different types of properties that can have a cost segregation study performed; and
- How you can benefit from the study to improve your cash flow.
If you would like more information on cost segregation, please contact TSP Family Office (772) 257-7888.
Transcript (edited for clarity)
Kami Elhert: Good morning and welcome to this month’s webinar, Improving Cash Flow Using Cost Segregation. I am Kami Elhert, Senior Client Relationship Manager at TSP Family Office. And today I am joined by Ted Zamerski and Greg Bell. Ted is a CPA, chartered financial analyst, personal financial specialist, chartered global management accountant, as well as the Director of Family Office Services at TSP Family Office. Thanks for being here, Ted.
Ted Zamerski: Thanks for having me, Kami. It’s always good to be here. And good morning, everyone.
Elhert: Also joining us today is Greg Bell. Greg is a senior member of the ASCSP and a fourth-generation builder who has been specializing in cost segregation since 2012. Welcome, Greg.
Greg Bell: Hi, good morning, Kami, Ted, and the audience. Looking forward to a good discussion today.
Elhert: Today we’re going to discuss what cost segregation is, how and when to use cost segregation, and how you can benefit from a cost segregation study to improve your cash flow. Let’s get started. Ted, could you tell us what cost seg is?
Zamerski: Sure, Kami. I’ll touch on it from a tax perspective first. When you acquire or build a building, you’re required to depreciate it over 39 years, or 27 and a half years for residential rentals. You get to slowly expense the cost of your building as it’s used up. When you think about it, that does make some sense. Since a building can last a long time, you’d expect to slowly experience some wear and tear as time goes by. But as you and I know, you either spend a lot of money upfront or you have to take out a loan to pay for the building. And then you only get to record the tax expense at about 2.5% a year. As we all know too, not everything that’s associated with the building will actually last 39 years.
The goal of a cost segregation study is to identify various systems and components of that 39-year building life and reclassify them to property that has a shorter lifespan. That allows you to deduct more of the cost of the building sooner, reduce your taxes, and keep more money in your business. While this sounds simple enough, there are a number of technical requirements as well that you need to take into consideration in order to take this deduction properly. Greg, before I kick that part over to you, I also know you mentioned that you’re a member of the ASCSP. Why don’t you tell our listeners, briefly, what that is and why it’s important?
Bell: Sure, Ted. The ASCSP stands for the American Society of Cost Segregation Professionals. This is a nonprofit organization that was established in 2006. The main reason it was established is that we needed to have some sort of a national organization that would allow the members to be further educated, a way credentials could be displayed, types of testing could be applied. And then, most importantly, the technical standards and a code of ethics within the cost segregation industry. Up until this time, there was really no organization or anything that members such as me could join to try to promote and designate us as a professional in this specialized field.
The main goal of the ACASPA is to provide its members, like I said, with educational programs. We do a lot of continuing education seminars and we have an annual conference. Additionally, we have what we call the minimum quality standards of cost segregation. These are the certain steps that members such as me pledge to adhere to and We have a code of ethics to maintain these technical standards. It’s a great organization. And it’s the only one in the United States where we can promote that certified experience of a professional cost segregation engineer.
Zamerski: So, it’s an organization to raise the level of professionalism and really the technical skills of the people performing the studies?
Bell: Correct. And the designation and the credentials that Someone receives as a member are strictly for individuals. It’s not like a corporation can join. These are all individual, much like an architect or an engineer would achieve from the same goal. So again, it’s an organization that offers individuals a way to achieve these procedural goals so that not only do we provide quality cost segregation studies to all of our clients, but we can also make sure that the reports that Kami will talk about later are in-depth and supportive of all of the reclassification of the property components that we actually analyze.
Elhert: I want to talk about that a little bit. What are some types of cost segregation studies that you’ve seen?
Bell: Well, as you know, Kami, we’ve performed numerous cost segregation studies for our clients here at Tax Saving Professionals. Probably the most prominent and the most common ones are when our client purchases a property, whether it be a commercial piece of property, medical office building or even vacation rentals, for instance. These are properties that are being purchased. We perform a study, and like Ted said, when you buy that commercial building, it’s all 39 years depreciation. We’re allowed to come in and we reclassify those components, either as 5-year for personal, tangible property or as 15-year for land improvement. That’s basically what we call a current cost segregation study.
Another that we’ve also done is what we call a lookback, or a purchase price allocation. Those are usually the most difficult to achieve because now we’re going back to a point in time. For instance, our client maybe purchased a building 15 years ago, let’s say. We now try to take a snapshot of how that building or how that property looked at the date that it was purchased so that we can segregate those assets at that point in time. Then, from our analysis, we’re going to usually get significant accelerated tax deduction that they should have taken that they haven’t. We’ll go into later how that can all be achieved.
Thirdly, the one that seems to be happening a lot because people are actually constructing new properties, is called new construction. In this scenario we assist our client in the selection and work with the architect, if we’re brought in at that stage of the development. During the construction process, we work with the general contractor to make sure that property assets that we have already previously identified from the plans will be able to create that cost tracking trail. We want to be able to identify the assets prior to them actually being constructed and placed in service to more accurately track those costs so at the end of the job, when the client has now put the building in service, we have everything tick for tack. We’re ready to go. And it’s pretty simple from that point on because the costs have been documented from actual invoicing, from the actual construction.
Elhert: What are some of the building components that can actually be broken out that someone might not think of? I know we were talking a lot about the building, but are there other building components that can be broken out that maybe we wouldn’t even think would be eligible for a cost segregation or a reclassification?
Bell: A lot of our clients’ CPAs say everybody can easily seize upon the very identifiable assets such as carpeting, pretty simple stuff, furniture. There are things that you can walk through a building and visibly identify as, “That’s the 5- year property.” But we take it to the nth degree. Because of my construction knowledge and the fact that I have been doing this since 1974, I have the background to actually analyze a lot of the components that aren’t visibly seen. I like to call these hidden treasures in the walls.
We can identify just one of them right up front. If everybody looks around, if you’re in an office, you have electrical outlets. You don’t really think that much about that outlet. But when it gets down to our analysis, that outlet, most of the electrical outlets in an office, are going to be what we would call dedicated outlets. They serve a purpose. They were put in place to serve an employee who would be working there Whether it would be for using your laptop, powering data or whether it would be for a printer, all of the outlets, would really be dedicated to a 5-year. So when you start thinking about that little outlet, the box that’s in the wall, the labor to put all that in there, the conduit that goes all the way back to the electrical panel, the wire in the panel, and then you start adding each one of those single components, start multiplying them by the amount that you have determined, it gets to be quite significant. There is just one part of a building component that most people really don’t even think about, but usually upon our analysis, you’d be surprised at how significant that amount can actually be when moved over to a 5-year classification. You’re moving it from a 39-year property classification to a 5-year property.
Elhert: Can you explain what some of the engineering requirements of a thorough cost segregation study are?
Bell: Yes. The IRS has a publication on their website called the Audit Technique Guide. This outlines four or five of the different types of scenarios. They have what they call the rule of thumb approach, which they basically even say not to use. But they have sampling, modeling; they have a residual estimate; they even have survey letters. In these scenarios people make an opinion just based upon what they think, or they will go to someone in the real estate business, look at a little picture, and say, “Oh, well, that’s worth this much.” When you get into the residual approach, they basically say, “Well, generally, offices are going to have about maybe 10%, 5-year.”
Those are the scenarios that are out there that, obviously, we at the ASCSP will not allow to be used. We have to use what we call a detailed engineering approach, and we’ll either use that from the actual cost records that a client might have, or we do a site inspection, which is another mandatory requirement for us to be able to produce our cost segregation study. This allows us to make the physical inspection to really look at the property. Once you use your eyes, and you can be in the field, you always discover more things that a picture would never show.
There are other firms that basically say, ” Just go do a video. Send a guy through with a camera.” Well, you can’t do that. It sounds great, but at the end of the day, our detailed analysis that’s going to take each of the building components and classify them into where we believe is either the 5- or the 15-year property component is almost audit proof if we ever get questioned by somebody from the IRS. That’s one of the reasons we use what we call either the detailed cost approach or a detailed engineering approach, which is where we’ll basically use our database and our computer software system to actually determine the actual cost of that building component while it’s there.
Elhert: Oh? There is a separate database? Because I have often heard of CPAs doing cost segregation studies or telling clients that one needs not be done, that they can expense everything for you. Ted, are there things that your CPA probably shouldn’t do that you can share with us?
Zamerski: I can think of a couple of them right off the top of my head, and these are things that I personally wouldn’t want to be doing representing a client as well. We talked a little bit about the engineering requirements. So having a qualified engineer review the building plans and schematics, performing a site visit, and actually doing a building inspection. That way, they can really see what’s behind those designs and see things that they’re going to recognize that you and I wouldn’t, as we talked about with the outlets, for example, and knowing what to do with those things. And I’d even think the invoicing from the contractor. I’ve seen them in all kinds of shapes and sizes where the costs are lumped in. But Greg and I were talking about, on one of the new construction programs that we were doing, that he was able to go back with the contractor and have them break things out differently so it’s easier to follow. So starting from the beginning and putting together that better support package, just knowing how to have that conversation with them and exactly what he’s looking for.
Elhert: And so, as I said, there are some CPAs who feel that everything can just be expensed out, and that they can expense everything for them. What should our clients know in case they do hear this, not just from a CPA, but maybe from another professional in their field or a friend or a family member who is familiar with that type of depreciation?
Zamerski: Again, I think I would have to say, what is your main objective here? Are you trying to get some expense deductions with minimal cost and effort, or do you want to actually maximize your tax savings with a professional study and an analysis that’s going to hold up to any potential IRS inquiries? You have to ask yourself, “Who’s in the best position to review the technical work? Who’s in the best position to interface with the general contractors and the IRS on your behalf?” I think it’s really easy to fall into the trap that it could be cheaper to get some things done. And you have to, again, keep in mind that cheaper today isn’t always cheaper in the long run, especially if that cost savings is coming from the result of shortcuts.
Bell: And let me add on to that, Ted. When we get into actually analyzing what is cost segregation, who is more capable of determining what an asset is, and again, if you look at the IRS audit technique guide, which is available on their website, they’ll even tell you that the quality cost segregation study – they’re going to give you all the different types of the principal elements – even the IRS acknowledges that the best person to do that would be an individual with the expertise and the experience. And obviously, somebody that’s in the construction field or is knowledgeable of the cost of the construction process would be the ideal person to be doing it. And beyond that, though, you have to have knowledge of the tax law. You have to understand that we have certain methodologies that we’ll utilize and that we’ll implement. And so, depending on what type of a building we’re looking at and what type of assets we’re reclassifying, myself and the ASCSP, we have very extensive court cases that have actually been won in favor of the tax person, paying the tax client. Being able to have the understanding and the knowledge of important court cases and how those types of court cases support the actual assets that you’re reclassifying wrapped into the methodology that we use, it has to all be prepared into a report where it’s all detailed. It’s not just looking at a line item and saying, “Hey, that’s an expense.” How did you determine that? There are different steps that we look at and we analyze. And so, most of your CPAs defer high-quality cost segregations to people who specialize in this field. I hope that maybe that tells you a little bit about how in-depth the actual study and the analysis is.
Elhert: Thank you for that. So, is there an ideal candidate for a cost segregation? Ted, Greg, do you have any input on who would be an ideal candidate for these types of studies?
Bell: From my perspective, anybody who owns commercial property and paid $400,00-$500,000 at minimum is going to benefit from it. And the vacation rentals that I mentioned earlier, somewhere between $200,000-$300,000. Each property is different. So, what we do, Kami – when our clients reach out to you and say, “Okay, hey, what do we do?” – we ask for all the documents and we tried to really perform our due diligence up front. We want to go through and look at each of the property components of each individual property. You can go over some of the items that we need but the always the best way is doing the due diligence upfront so that we can actually look at it. It’s hard to really put a dollar value on them. But obviously, the more the property or the assets are worth, the greater the benefits are going to be.
Zamerski: Most of our clients, I’d say, except for ones that are real estate professionals and some that actually are generating some significant passive income, are subject to the passive activity loss restrictions. So, it may not be as effective for them to generate excess losses that they can’t deduct. And maybe they’re going to be better off recognizing some depreciation each year. What are some of their options with regards to the single-family vacation rentals in this case?
Bell: That’s a good point, Ted. A cost segregation study serves two purposes. Obviously, number one is, “Hey, let’s accelerate depreciation.” We can offset money by taxes, what we have that are due, in the event where maybe they didn’t need to offset their taxes because maybe it is a negative producing piece of property. Keep in mind that the accelerated depreciation always carries forward. You don’t have to take all 100% bonus this year. You can break it out over the future. But even more importantly, sometimes is a cost segregation study will give you the basis.
When you buy your rental home, let’s take an AC, for instance. The day that you buy it, it doesn’t matter if the air conditioner was in new condition or whether it’s on its last leg. That air conditioner is going to be assessed at a value and it’s going to depreciate over the next 27 years or so. With a cost segregation’s study, at the time when it came to replace the air conditioner, let’s say maybe two years after you bought the property, there would still be 25 years of a partial disposition that you could take and actually deduct that because your new air conditioner is going to have to be capitalized. Therefore, a cost segregation study gives you a point in time of every asset in the property and what the value was at the date that you actually purchased it. It does allow you, if you elect to, to take partial disposition and at least sort of gain back some of that depreciation that you’re never going to realize because you threw the unit away. That’s only one aspect.
Zamerski: And that’s a really good point. You mentioned $300,000 or so for maybe the residential properties. $500,000 and up for the commercial buildings before the studies tend to make sense. What about length of building ownership for lookback studies? Is there a sweet spot there or a point where it just probably won’t make sense anymore?
Bell: Well, 15 years is probably about the maximum. I mean, and as Kami will attest to, we’ve had some of clients who have requested that we do this, and we call that the lookback study, and it’s been very difficult. They’re challenging, let’s say. Because somebody that’s owned their office building for 15 years, I mean, do you have documents that can basically show or allow us to analyze what that building was? If you had a real estate appraisal done on the date that you purchased it 15 years ago, we’re golden. We’re good to go.
The good thing about is, as we talked about the different types of asset categories, the big one that most people miss is land improvements. And the land improvements are everything outside the building footprint. So, you have a small little office building or a strip mall or whatever you have, you have to think about, “Okay, what about the sidewalks? What about the curbing? What about the asphalt parking? What about all the landscaping, the grass, the retention pond?” There’s a lot to consider. Once we perform our analysis on that, that’s all going to be reclassified to a 15-year property. So, in the situation that you proposed, Ted, if we were to even go back 15 years, we would take that whole 15-year benefit and bring it forward. We would accelerate that forward along with the 5-year. What you would have, is even on a 15-year lookback study, you would have a significant amount of accelerated depreciation that you should have been doing once you took the building 15 years ago. We use the IRS form 3115 to capture that.
A second part of the apple that you get to bite out of when you do a cost segregation on a lookback study whether the client did improvements? Almost anybody who’s had a property for 15 years has done improvements. And if they’re detailed and they’re documented, we can actually go back and look at each one of those improvements and maybe even carve out more money that can be accelerated. So older properties are very ripe. Again, the challenge is in the documentation process, of trying to go back and grab the records that we would need.
Elhert: And with that there have been some recent legislation changes as well as presidential changes. Ted, have there been any recent tax law changes or updates that would impact cost segregation?
Zamerski: As a matter of fact, the most recent updates came out of the CARES Act, believe it or not. While most people were focused on COVID relief payments and PPP loans, there was actually some additional relief generated in the area of cost seg as well. Two quick points to make on that.
First, there was the technical correction in the law that classified qualified leasehold improvements –think your renovations as 15-year property, but more importantly, made that eligible for 100% bonus depreciation. That means now, as Greg was talking about, that you get the write off all of your 5-year and 15-year property in the first year you place your building into service. Or, if you did it in 2018 and ’19, you can go back and catch up those adjustments as well.
The second area was in the area of net operating losses. Back in 2017 with the Tax Cut and Jobs Act, they eliminated the ability to take a net operating loss and carry it back into a previous year. You could only carry it forward to offset future income. Well, the CARES Act restored the ability to go back into the past. Now you would actually be generating a refund on an open tax year and you can file the amended return. That way, you actually get your money back quicker than if you had to wait till next year when you file the current year’s taxes. Both of those were opportunities, and the intent was to put more cash back in the hands of business owners.
Bell: Ted, I’m glad you mentioned the Tax Cuts and Jobs Act because one of the aspects that a lot of our clients and even some CPAs missed was when it was implemented was that they made it retroactive back to September 2017. One of the biggest things about the Tax Cuts and Jobs Act was cost segregation. The ability to get your 100% bonus depreciation has always been for new construction. Some of our older cost segregation studies could be reclassified property to a 5-year accelerated depreciation, but it was usually only on a 200% declining balance. So you only grabbed half of it. Well, one of the great things about the Tax Cut and Jobs Act is by moving, like you just said, everything to all-accelerated tax. Regardless of whether it’s 5-year or 15-year, it now becomes 100% bonus depreciation, which means you get it right now.
The other great thing was they also allowed us to go back and look at used property. In the past, used properties never had that benefit. For instance, any of our clients who have purchased a used building after that magical date of September 2017, if we were to perform a cost segregation analysis on that, all of those assets, 5-year and 15-year would be treated just as if they built the building new today. All of it, 100% bonus depreciable.
Elhert: Great. And it does look like we do have a question from one of our attendees here. “In the residential space, does the cost justify it for SFRs?”
Bell: Yes. Again, what is the intent? And SFR would be single-family residence, I’m assuming. If it is a vacation rental– it can be a condo, it can be an apartment, it can be an apartment complex, it can be a single-family residence. As long as the tax flow actually goes through that entity itself. Most of our rental properties or vacation rentals are set all up in an LLC. Is that right, Ted?
Zamerski: Generally, most will do a single-member LLC, and then that actually just flows back onto their personal return very easily. And it’s important to put them in the LLCs from an asset protection standpoint. The last thing you want to have happen is somebody trips on the stairs and hurts themselves. It would be bad enough if they could take that house from you, but you don’t want them taking your other assets as well if you just own it personally.
Elhert: Going along with that, they’re specifying for a single-family residence. Is that specific, or is that just for ones that are over $500,000?
Bell: No. Not at all. There really is not any type of an entry or beginning level. And again, each property is unique. So, I mean, you might have, for instance, a lower-valued piece of rental property. But if it was down in the Keys and it has a dock and it has a pool and it has a gazebo and maybe a tiki bar, all of those are site improvements, a huge portion of the value of the home could be moved to a 15-year component. Each one is different.
Zamerski: Kami, I just want to add to that too. I know you’re going to go through the process in a little bit, and that’d be a good point to point out when you get to that. But each one of these, we’re going to look at them and see if the cost of the study justifies the savings. And we’ll look at it from that standpoint before anyone has to proceed. It doesn’t hurt to take a look, I guess, is my point.
Elhert: Absolutely. And only for multi-family, is there a minimum number of units that would justify the cost that you’ve seen in your experience?
Bell: No, I mean, some our clients have a small little duplex. Let’s go. We’ve done some that have multiple duplexes all the way up to large apartment communities.
Elhert: That’s good to know. Earlier you mentioned case law as it relates to the cost segregation studies. Can you explain the importance of case law in your work?
Bell: One of the most notable court cases was a U.S. hospital versus the U.S. Basically, that was a hospital corporation, and that’s really what sort of started the ball rolling on cost segregation. The taxpayer, they prevailed in court. But think about it, a hospital, all of the medical equipment, and not so much the equipment itself, but all the specialty rooms, X-ray rooms. Think about operating rooms, all of the different things that you have to do to make that room sterile, the air conditioning systems, all of the supplies, the medical gas and so forth. That case really became the foundation for how we can take certain property components and reclassify them because they really don’t have a function to the building. They have a function to the business and that’s how cost segregation basically works. That overlaps, like we said earlier, with the electrical distribution system.
Another one of them was Scott Paper versus the U.S. Scott Paper was a huge manufacturing plant. They had a lot of production equipment and it took a tremendous amount of electricity to power up the whole plant. Well, the building was great. The building is 39 years. But what about all this electrical that they brought in to be able to make all the machinery function? Again, they prevailed in that case and it allowed us to say, “At the end of the line, what is being used and if that is a dedicated piece of equipment, then everything going from that going back is all going to be deemed 5-year classified property.”
There are numerous court cases that we use and that we will cite in our cost segregation study because, at the end of the day, there’s not a list that you can actually go down. Each individual component that we look at has to be justified and has to be supported by some sort of a case law. We don’t ever want to have our clients be jeopardized by the wrong end of an audit.
Elhert: That’s a good point. And gentlemen, let’s take a few minutes and talk about some benefits of cost segregation.
Zamerski: Sure, Kami. I think that’s one best illustrated first with an analogy and then I’ll run through an example.
I think everyone here is familiar with the three most important rules in real estate, and that’s location, location, and you guessed it, location.
And I think business is not really much different. The three rules are cash flow, cash flow, and does anyone want to take a guess at the third one?
Bell: Cash flow.
Zamerski: Cash flow. Absolutely. Said differently, cash is king, or to quote one of my colleagues, David Babinski, “Cash is the oil that keeps your business engine running smoothly.” We’ll just run through a quick example and we’ll keep it pretty straightforward. If we’re starting before a cost seg study, we’re looking at a purchase price in this example of about $8.9 million and we’re going to depreciate that over 39 years in that first full year. Depreciation expense is going to be about $230,000. Assuming you’re in the 37% tax bracket, you’re looking at a tax benefit of about $85,000. It’s nice to have that, but we know you put out a lot more money than $85,000 in order to secure a $9 million building. After having done a cost seg study on this building, we’ve now reclassified some of that property, as Greg was explaining, to 15- and 5-year property. So, the depreciation expense was actually now over $1 million on this particular project. Still, at the 37% tax bracket, you’re now looking at a $390,000 tax benefit. The difference between the two is $305,000. And this is a new-build project, so it’s actually still ongoing. And I know, Greg, we’ve still been getting additional expenses and things coming in, so I’m sure it’s probably going to go up from here. But that’s certainly a substantial amount of cash back into this particular business owner’s hands.
Elhert: Wow, that’s great. What do you think are some things that business owners could do with that extra money? I mean, obviously, they could save the money. But could you think of any other things that they could do with just that extra cash flow?
Zamerski: Yeah, absolutely. If you step back and look at your business, your operations, a couple of considerations are maybe now you’ve got the cash to expand your practice; knowing you’re going to get this extra depreciation expense, maybe you could buy the building sooner. Or – Greg, I know you’ve had a number of instances in this case – when we’re looking at this in advance and in the planning stages, knowing these differences can allow for the purchase of a bigger space.
Bell: Most definitely. And another thing, like we always alert our clients to, is it doesn’t cost anything to have Tax Saving Professionals take a look at the property prior to the purchase and based upon even Google. Sometimes I’ll even look at the property appraiser’s website. There’s a lot of information we can gain prior to the client purchasing the property, which would allow us to perform the due diligence that Kami and I do, so that we could then determine what a potential tax benefit for this property is that you’re going to receive – and again, that would be on the conservative side – if you go on and purchase the property. And as I’ve always expressed to the client too, Ted, if you know you’re going to be getting back X number of dollars upon date of purchase, well, maybe you don’t have to borrow all that money from the bank. Maybe you can reduce your capital reserves that the loan officers want. There’s a lot of things that you can do. Maybe you decide to get a bigger piece of property. But even if you’re zeroed and dialed in on that certain piece of property, I’m sure you can use the advantage of what you think you’re going to be receiving and be able to use that accelerated depreciation as leverage with your loan officer to maybe reduce some of the costs that you might be having to put in place.
Zamerski: I always looked at these as comprehensively as possible. If this is one area that brings additional cash back into either your business practice or ultimately to you personally, then we like to look at how else can we combine other strategies together? What other things can we put together and really start to compound and leverage that savings through any number of the family office offerings that we have? This can allow you to fund something else that’s going to grow on top of it as well.
Elhert: In addition to that Ted, we talk about timing, too. With the analysis of the savings, running that against the other savings, will it be best to do it in this year or is it maybe something you will benefit from next year? Make sure that the analysis throughout all of our family office services are being considered for what’s best with our clients, too.
Zamerski: Multi-year planning is imperative to do that, as well as looking for maximizing the benefits and trying to optimize them. So good point, Kami.
Elhert: I want to take a minute and outline a bit of the process for you as far as cost segregation here at Tax Saving Professionals. What you want to do is reach out to me if you’ve purchased a building within the last five years or are contemplating doing so in the next year or so, so we can begin to have the conversation. I’ll request a meeting with you and one of our financial strategists. At that time, we’ll discuss details about the building and request various items such as depreciation schedules, building cost projections, appraisals, closing statements, etc. Your team will then review the documents to assess the feasibility of the cost segregation study. We’ll also request more detailed information like surveys and construction drawings. At that point, a preliminary report, as Greg said, will be issued outlining the projected benefits and tax savings from completing a formal professional cost segregation study. Your team will review the preliminary report with you, along with the terms of the engagement, the cost of the study and the preliminary net savings to you. Once you agree to the proposed engagement, I will coordinate with your primary contact as well. I will be your primary contact regarding the progression of the actual study and how it is coming along. When the time comes, I’ll coordinate with Greg to have the engineering onsite visit. Upon completion of the engagement, a final cost segregation study report will be issued to you. That will include items including but not limited to a narrative of the property, a detailed cost analysis of all the qualifying assets – including personal land improvements – building, pictures of the property, as well as updated depreciation schedules, case law citations, and, most importantly, IRS Form 3115.
And now I’d like to take some questions from the audience. “How much does a cost segregation study cost?” I have typically seen them range from $7,500 to about $20,000. The point to remember is that is you will not be charged for any preliminary analysis, and you will have your tax-saving projections and costs of the study prior to signing any official engagement letter. We do view the project from a cost-benefit standpoint, and we’ll even bring forth a proposal if the tax savings does not sufficiently exceed the cost of the project. So, we’re looking at this from all different directions.
Here’s another, “How long does a cost segregation study take to complete?”
Zamerski: Greg, you talked about this throughout our discussion, that everything is different, right? Everyone is unique and individual. So the answer really is it depends. But I think if you’re talking new construction, obviously this is going to go on throughout the build period. And I think we touched on that the sooner you start this process, the better because there’s so much that goes into it. When you look at even those lookback studies, it’s going to depend in part on not just our team, but the individual doing this as well, the building owner. You’ve got to be able to track down those documents. You may need to do some research in order to find them or put your hands on them because, without them, you’re pretty much dead in the water without the docs. We can’t emphasize that enough. But hopefully when you see the potential savings that you’re looking at, that’s a little extra motivation to find where they are. But, if you’re like me, you’ve got your last 10 purchases all shoved in the back corner of a safe somewhere and you never clean it out. So that might be a good place to start looking.
Elhert: Greg and I are here along the way as well. We do actually try not to overwhelm you, but there are items that we send out to the clients that are requests for information. We’ll be taking it step by step on how we can begin to start the process of the study.
Zamerski: I’m looking at a question that just came in, and Greg, you can jump in behind me if there’s anything you want to add. “If you compared all asset classes at the same price, which asset class benefits from the cost seg the most?”
Everything’s starting in that thirty-nine-year property so anything you can move up to the 5-year property, you’re making up and getting a bigger deduction because of the length of time. But I think most of the items that you find are probably falling into that 15-year range. I think it’s just a bigger category that captures assets. So that might be more bang for your buck just on the size of it. Anything else you want to add to that?
Bell: Again, each project is so specific. Sometimes you can do a larger building and, depending upon the function and use of the building, let’s say like a medical office building, those are usually always super candidates because every doctor’s office is going to have its own little private waiting room, examination rooms. Usually, you’re going to have the cabinetry, you’re going to have a sink, you’re going to have all of the outlets that we talked about earlier. When you start adding up all of those various components in each and then you get out into your reception area where you have all your desks, maybe all your accounting, you might have an accounting main room. You might have a lot of data, and even a data system is huge, whether it be a Cat 6 or all the different types of IT rooms that are available, and how that whole office functions. When you start adding up all of that, it could be quite significant in 5-year property versus the 15-year.
Then, on the other hand, you can take a smaller piece of property that’s maybe more of a strip mall, and maybe there’s not much in there. But, boy, all of a sudden, if you have a large parking lot, you have beautiful landscaping. I mean, it can go both ways. But again, the fact is, whether it’s 5-year or 15- year, you’re going to still gain the benefit.
Zamerski: Greg, as you were rattling off some of those items that got me to thinking, especially the doctors’ offices. But it doesn’t have to be a doctor’s office. You’re looking at a lot of sizable equipment. A lot of people may be using Section 179 to write-off and expense that equipment. But we know that has limits as well. You can only write off up to a $1 million deduction, a little bit over that. And when you get over $2.5 million, $2.6 million, I think it is now, when you start exceeding that in total purchases for all of your assets, then you start getting that dollar-for-dollar reduction of the expense. I think you and I have talked about how you can wrap that into the cost seg study and kind of get around those limits a little bit or expand upon that.
Bell: Most definitely, especially on new construction. Our client is obviously going to buy furniture. Well, everybody says, “Well, great, furniture! I can 179 expense that.” Maybe that’s what your CPA says. However, we can also consider that as an asset that is being placed in service at the time of the property. Therefore, that actually becomes part of the construction costs which would fall under the guidelines of the cost segregation study. Some of our projects that we’re doing right now, Ted, we have huge amounts of medical equipment that are been being brought under the umbrella of the cost segregation study, along with the furniture and all of the TVs and the monitoring and the computer systems, all of which could have been done as a 179. But once you get to that limit – and the one client that we’re working with right now would easily exceed that –then what do you do? We’re using the advantage of a cost segregation study to capture all of that immediately classified as a 5-year property. You get the same treatment of 100% bonus right now as you do expensing it if you were to use a 179.
Elhert: Wow. That’s a great. Well, gentlemen, that’s all the time we have today. If you have any additional questions or just want to learn more about cost segregation, please call us at (772) 257-7888.