When I first began working in the area of cost segregation, people would ask, “What do you do for a living?” I would respond, “I explain to people what I do for a living, because no one has ever heard of it.” At the time only the large accounting firms provided this service.
Over the past decade, however, the cost segregation market has spread to small and medium sized investors and businesses. Despite the rapid growth of service providers nationwide, there are still underserved businesses and markets.
Building owners who acquired or built commercial buildings in prior years are often overlooked. There is a common misconception that only new construction qualifies for the benefit of cost segregation. However, anytime a building is built or changes hands, depreciation starts over, and a study can be performed. Cost segregation front-end loads that depreciation, so the owner recoups money faster.
When looking at buildings placed in service in prior years, the missed depreciation gets caught up on the tax return in the year of the study via a change in method of accounting (Form 3115) and a §481(a) adjustment.
For example, if you purchased a building in 2000 for $5 million and put it on the books as 39-year property, the straight-line depreciation would yield an annual deduction of $128,000. Through a cost segregation study, we reclassify 12% in 5-year and 8% in 15-year property. Because of the §481(a) adjustment, the additional current year deduction (above and beyond the depreciation already taken) would be $624,500, which would result in a current year cash flow increase of $218,575. The net present value over the entire tax life of the building is $149,110.
Due to the Tax Reform Act of 1986, we can conduct a cost segregation study for any commercial or rental building, constructed or acquired, since January 1, 1987. Ideal properties are those built or acquired in the last 15 years, but many good opportunities exist back to 1987.