Do you own your company's facility or another type of commercial property? Are you looking for a way to boost your cash flow? There are a few things a tax planner can do to reduce your tax liability and give your cash flow a boost. One of the most effective ways is performing a cost segregation study.
Cost segregation studies are performed by a team of tax planners and engineers. They involve a review of your property to determine which parts of your property should be classified as real property, which should be considered personal property, and which should be considered land improvements. Real property is generally considered to be the building itself and any components of the building that are critical for the building's operation. That includes the materials that make up the building's structure, as well as vital components like lights, doors and utility equipment.
However, tenants improvements and fix up to will likely qualify for favorable tax treatment. Personal property includes equipment and other materials that are attached to the building, but are not vital to the building's ability to function. This can include a wide variety of materials, such as some types of flooring, add-on facilities like cafeterias and even certain types of air conditioning and heaters. Over the years, the IRS has ruled on what does and does not count as personal property. Generally, that list includes items that were chosen to be added onto the building, not items that were necessary during construction. Tax professionals and engineers who are knowledgeable in tax segregation studies are the best ones to determine whether something classifies as personal property. During cost segregation studies, the tax and engineering team is also looking for land improvements. These include optional features that you've constructed on the land around the facility, such as an outdoor patio, a lighted parking lot and a walking trail for employees.
The main reason to do a cost segregation study is to change the depreciation schedule of some of your property. Far too many property owners depreciate every piece of their facility on the real property schedule, which is 27.5 years. That means they're recapturing little depreciation each year, but doing so over a longer period of time.
The IRS has ruled that personal property and land improvements can be depreciated over shorter periods of time. Personal property can be depreciated over either five or seven years, depending on the type of equipment. Land improvements can be depreciated over 15 years. The net effect of changing the property types is that you'll take a larger depreciation cost on some items each year, reducing your tax liability and increasing your cash flow. As an added benefit, your municipality may have different ways to tax land improvements and personal property, so the cost segregation study could also have a positive impact on your property taxes.
The short answer is: any time. If you've never had one before and you own a substantial amount of commercial property, you could probably benefit from a study. Good times to consider a cost segregation study include:
This is probably the best time to do it. You should involve your tax planner and your engineers in the process as early as possible. They can identify items that would classify as personal property or land improvement before the building is even built. That means you could build the facility with depreciation in mind and with the goal of maximizing your cash flow from day one.
Again, it's always better to capture that depreciation as early as possible. Cost segregation studies are always a good idea when you're looking at buying a facility. A cost segregation team could review the building in advance and give you an idea of how it could be depreciated and how it would impact your cash flow. They could also offer advice on any improvements that you plan on making and how those would affect cash flow from a depreciation standpoint. That allows you to be fully informed when you make the decision to buy.
Maybe you bought your building a few years ago and never had a cost segregation study done. That's no big deal. Your tax planning and engineering team can still do a study today. They can even calculate what depreciation costs you should have claimed in the previous years. You can then recapture previously unrecognized depreciation for an instant cash flow boost.
You probably already work with a CPA or other tax professional. While they may be familiar with depreciation, that doesn't automatically mean they're qualified to lead a cost segregation study. You need someone who has extensive experience with cost segregation studies and who can coordinate a team of engineers to implement the study.
Cost segregation studies are very complex, so it's important to work with an expert. The IRS has stated which pieces of equipment fall into which categories, but the rules are complicated. Air conditioning units may be personal property, but it depends on how they're used. Flooring could be personal property, but it depends on why the flooring was installed and what would be there otherwise. There are subtle intricacies to each rule that require in-depth knowledge.
If you want a cost segregation study, ask your CPA or other trusted professional for a referral. They likely have a cost segregation expert that they rely on for such work. When considering a cost segregation expert, be sure to interview a few different teams.
A cost segregation study is a large undertaking and shouldn't be entered into without doing your due diligence. Be sure that you understand their process. Also, you want to be sure that you're comfortable with their level of aggressiveness. They may be very aggressive in reclassifying assets, even reclassifying those that may be borderline cases for changing asset types.
If the IRS disagrees with their assessment of assets, they could end up with unfavorable audit finding. If you're not comfortable with an expert, keep looking until you find the right match. Cost segregation studies are must-haves for business owners who have substantial commercial property assets. It's a critical cash flow management tool, so make it your priority to talk to your tax professional about how a cost segregation study could benefit you.
