Ultimately, cost segregation is an income tax strategy for owners of commercial real estate. Knowing your provider uses a Detailed Engineering Approach sets your study up for success. Still, to achieve the highest IRS refund or the lowest income tax due, it is the expertise of the cost segregation tax advisor who will either maximize your savings or leave a lot of accelerated depreciation unclaimed. Worse than that – a poor study creates an environment where IRS audit would be painful. Having a poor quality study is worse and more expensive than having no study completed at all.
- If you are paying for a cost segregation study, you want to receive every dollar allowable. Detailed Engineering Approach studies go through every inch of electrical conduit, every wall-mounted door stop, every bolted down bollard to provide the maximum accelerated depreciation. Providers who do not spend the time to examine your property in this level of detail are missing significant value and are also creating audit hazards for you.
- Though there is no such thing as being IRS audit ‘bulletproof,’ by using the highest standards set forth by the IRS in its Audit Technique Guide (ATG), you can ensure that the IRS favors the methodology used and that all items are allowed by tax court precedent. Though the IRS Audit Technique Guide does not require any specific methodology, when the ATG states concerns about the validity and accuracy of other methodologies, as a commercial real estate owner, you should avoid them.
Does the provider examine all available plans and drawings? Or create working drawings when none exist? Does the provider examine all available cost information from the client and contractors, and subcontractors?
Examination of the details of a project, both from an engineering and cost perspective, is required to give you a high-quality study.
Does the provider conduct a property tour lasting several hours?
A quality study should photographically document all visible segregated items. ‘Drive by’ studies where a tour lasts only a few minutes, with limited documentation does not meet this highest standard.
Does the provider prepare line item take-offs, such as the image below, tying in all costs to either an invoice or an approved engineering estimating reference allowed by the IRS?
|RSMeans 09 65 13.13 1100||Resilient Base, classic profile, 4”, Vinyl||94.00||L.F.||219.25|
|RSMeans 22 41 16.30 3000||Sink, Stainless Steel, 19”x18”, single bwl.||1.00||EA.||736.84|
|RSMeans 22 41 16.30 4980||Rough in, supply, waste & vent||1.00||EA.||937.40|
|RSMeans 10 26 13.20 0500||Wall corner guards, vinyl acrylic, adhesive mount, 3” leg||91.00||L.F.||1,158.73|
|RSMeans 08 71 20.50 1300||Door Stop, Wall mounted, 4” dia. Aluminum base, rubber pad||1.00||EA.||26.60|
What cost segregation approaches should be avoided?
Cost segregation is not a commodity. The value is in the quality of the work. Approaches that cut corners decrease the cost to the provider and the fee to the client, but these cost-saving measures come at the expense of the client, who is not receiving a quality study.
Cheap, poor-quality work is the most expensive service you can buy.
Percentage Estimating, sometimes called ‘Rule of Thumb’
If a provider is simply breaking down a building into percentage categories, for example, 30% electrical, this is a clear indication you have received a Rule of Thumb study.
ATG states, “An examiner should view this approach with caution since it lacks sufficient documentation.” Do you want to hire a firm using a methodology that is being viewed with caution?
Sampling or Modeling
This is a method sometimes used when the same entity owns multiple properties of very similar types. – An example would be multiple fast food locations of the same franchise.
ATG states, “A frequent issue is the accuracy of the sampling results. …despite the fact that facilities within certain strata may appear to be very similar, variations in building codes, geographic location, and material and labor costs may make it difficult to determine an appropriate model.”
Find out how much YOU COULD SAVE with a cost segregation study
How do you know if your cost segregation tax advisor is what the IRS Audit Technique Guide (ATG) calls ‘an individual with expertise and experience?’ See our guide to providers – asking these questions of a tax advisor will help you discern their knowledge and expertise.
Key elements which indicate an income tax advisor’s expertise with cost segregation:
Tours are conducted by two professionals:
One tax law expert, one construction and engineering expert.
Separate Income Tax Accelerated Depreciation Schedules for Federal and State filing
Because the states do not all conform with the federal rules, separate schedules are required for accuracy.
Each member of the touring team has several years of experience, full time, providing cost segregation studies
Cost segregation is a niche practice area. It is not an area of examination on the CPA exam. For this reason, hours in the field is an integral part of learning this specialty. The least experienced person on our leadership team has been conducting cost segregation studies for 12 years. The most experienced has been conducting studies since the 1970s when it was called component depreciation.
Tax Advisors do not sell other services (such as investing) based on cost seg savings or charge a percentage based fee
Though not explicitly illegal, the IRS is clear that providers should have no interest in the study results and that compensation should not be based on study results.
Tax Cuts and
Jobs Act (TCJA)
The Tax Cuts and Jobs Act didn’t just adjust how commercial real estate owners can reduce their income taxes. Instead, it completely flipped the script, unlike anything seen in tax law in over 30 years.
Great income tax advisors in the area of cost segregation are knowledgeable about all the changes to areas such as:
- Section 179
- Bonus Depreciation
- Qualified Improvement Property
Most of our clients have seen increased accelerated depreciation and cost segregation study value, and we’re excited to bring these new income tax savings to future clients.
There is a common assumption that values have decreased due to the adjusted corporate income tax rates. However, in practice, only a handful of commercial real estate owners have experienced decreased value. On the contrary, for most, values are higher than ever before.