Cost Segregation Study Insights

A cost segregation study is one method for reclassifying property assets to accelerate depreciation and unlock substantial tax savings. This approach not only enhances your financial planning but also optimizes your tax position, making it a valuable tool for any business. Our dedicated team at KatzAbosch is committed to helping you navigate the complexities of tax regulations and maximize your financial outcomes. Watch our video to learn more about how cost segregation can positively impact your bottom line.

Cost Segregation Study – Transcript

Hi contractors, Kristin Bailey here, CPA and certified construction industry financial professional at KatzAbosch, a CPA and consulting firm that specializes in construction contractors. This month we’re talking about cost segregation studies which can create a huge tax benefit not just for contractors but for anybody who owns commercial real estate.

A really broad overview of a cost segregation study is when a building is placed in service, it’s depreciated over 39 years for federal tax purposes. But with a cost segregation study, the building owner, the CPA, and an engineer can work together to identify parts of that building that can qualify for shorter life depreciation – 15, 5, or 7 years. With this shorter life depreciation, not only are you accelerating your deductions from 39 to maybe 15 years, but you could also qualify for bonus or section 179 depreciation, creating a huge deduction in the first year the building is placed in service or the year that you have the cost segregation study done.

Here with us today we have Conrad Jennings from the Jennings-Danovich Group. Conrad has been doing cost segregation studies for over 21 years and has assisted many Katz Abosch clients with cost segregation studies, saving a lot of tax dollars. So Conrad, thank you so much for joining us.

Conrad Jennings: Thanks for having me.

Kristin Bailey: Can you tell us a little bit about what is an ideal building for a cost segregation study?

Conrad Jennings: Well, ideal buildings are primarily going to be those that are based on the type of property or type of business being done within that building. It also can depend on whether it’s an urban or rural type area, where urban tends to not have all that much site improvement, which is where we get a considerable amount of money when you have a rural area that has parking, landscaping, lighting, storm sewage, and that kind of stuff that we can take in 15 years. It also depends on the type of business going on, say if it’s just a standard office or is it a medical office, a dentist office, a manufacturing plant. The manufacturing plant probably is your best bet because any of those that have considerably more mechanical, electrical, and plumbing type requirements, which is what we go after, can have a considerable amount more of an accelerated component.

Kristin Bailey: Can you give us some examples of items that might qualify for five, seven, or fifteen-year property? What inside the building can we accelerate depreciation on?

Conrad Jennings: Yeah, I’m going to go back to that mechanical, electrical, plumbing because that’s usually where a lot of money is at, especially the electrical. If it’s a standard office, usually your HVAC, your mechanical, is primarily going to be for creature comfort, and if it’s creature comfort then it’s not anything that can be accelerated. However, if they have a computer room that has an HVAC unit within the computer room that’s there for the computer systems, that is of course available to take. In medical or dental offices, there may be specialty exhaust, specialty gas lines, gas systems, compressed air – all of those items we’re going to look at. Over and above that would be items such as your interior finishes, wall coverings, floor coverings, cabinetry – so, you know, there’s a lot to look at but you’re going to get a lot of bang for your buck for your site improvements as well. So the combination of those is really where we can get most of our benefits.

Kristin Bailey: How does a study differ if you are buying a building and renovating versus building a building?

Conrad Jennings: Well, in building a building, you know, we don’t normally speak to the client prior to, so they’re going to build a building the way they want. We’re just going to basically be what we call reverse engineers. We’re going to take those drawings and costs and evaluate what is built. So a new construction we would not do until the actual building was complete. We could see the site visit but we won’t actually do the job until we actually have final costs, which would normally be a final AIA contractor payout and then all the additional soft and hard costs that are paid outside the general contractor that need to be capitalized against the project.

As far as purchases, the purchase is going to be primarily your settlement closing statement, your purchase price. Now some people take that purchase price and allow for some of the closing costs within that to be capitalized as well, which probably should be. And then what we do is get the land allocation for that property. So that purchase price plus any closing costs need to be capitalized, and then you subtract the land allocation – that gives us our basis. Then we go in and do a site visit, which we do assignments on every project we do, and evaluate all the components at that point and price everything and tie it to that tax basis.

Kristin Bailey: How about for a renovation? Is there any difference there?

Conrad Jennings: Renovations are obviously going to be a higher percentage, so that’s why the renovation cost basis can be lower because we’re not looking at all that structural component that you’re looking at from a ground-up construction. But you’ve got to keep in mind that if you purchase and there are renovations that are going to be done, we need to see that purchase prior to any demo and renovation work being done. You also want to remember that if you purchase property then have the intent that the owner has the intent when he buys that he’s going to gut it, redo it, then whatever is going to be demoed would have absolutely no value. So in that case, we don’t have to evaluate whether it’s even worth doing a cost segregation study at that point.

Kristin Bailey: And then as far as the cost of the building or the renovation, are there certain guidelines that you say above a certain amount is an ideal candidate?

Conrad Jennings: Well, obviously the more money we have to work with, the better the numbers are going to look. But again, it goes back to the same thing – we do a free estimate. Once we evaluate the building and what type of business is going on, what we think we can get out based on the experience we have with that type of property, then we can evaluate an ROI. But as we were talking, the tenant improvements – it can be as low as two or three hundred thousand if it’s a tenant improvement to a property such as a dental office or a medical office building or an addition to a manufacturing plant or refrigeration storage facility. Those are the types of items that are going to have a lot of extra pieces and parts that you wouldn’t see in a standard office building.

Kristin Bailey: Is there anything about the current tax laws, the current tax environment, that makes doing a cost segregation study more advantageous than in the past?

Conrad Jennings: Well, the biggest thing was the TCJA giving us bonus depreciation on purchase property, which had never happened before. We’ve never been able to take bonus depreciation on a purchase, so that was the biggest thing by far. And then bringing back 100% bonus depreciation as well. The other thing might be the QIP, which would be getting rid of the old system, going to the straight QIP, getting rid of the old QLHI, QR, QRP – which was a big headache when we had all those going at once. So I would say those would probably be the biggest at this point.

Kristin Bailey: Just for our viewers, all the initials Conrad was using referred to the different types of improvement properties. But now we just have one improvement property category to work with, and it’s now 15 years where there were a few years where it was 39. Thank you for clarifying that. Sometimes they get a little carried away with the initials.

Conrad Jennings: I do too.

Kristin Bailey: The clients are always like, “What is that?” They’re emailing me.

Alright, we have a building owner that wants to have one of these done. What are some of the documents you should start to gather to be ready to meet with you?

Conrad Jennings: For a purchase, basically we need a depreciable basis. So normally what we ask for is the settlement closing statement, then we usually verify with the CPA whether they want to use – but for estimating purposes we probably don’t need to, but they may upfront decide they want to use some of the closing costs. We need the land allocation, usually that’s arrived at through tax records possibly or appraisal. We do need an appraisal because the appraisal will give us the layout of the land, sometimes a lot of times has pictures – internal and external properties that helps us to kind of visualize. We also need an ALTA survey, civil-type layout drawing which gives us an idea of the amount of land involved, how the building sits on the land, parking lots, it usually shows all those items and that gives us a pretty good idea of what we’re going to find inside the crews. And then it’s usually a full city, state, and street address so we can look at it on Google Earth. We get a lot of information from that, so that’s very helpful.

As far as new construction, primarily what we’re looking for there is the pay app, AIA document, the contractor application for payment. There’s a couple different names that people use, not everybody uses the standard AIA document but they all know what it is. We really need that construction category breakdown similar to an AIA document, then a summary of those other capitalized costs we talked about earlier, the other hard and soft costs that need to be capitalized against that are outside of that AIA, and then a description of the project with that same type of address information we asked for on the purchase. The reason we ask for that is just that we know what kind of business is going on in there, because sometimes in a new construction we won’t see anything on Google Earth, but sometimes when we have the address we can go to Google and actually find some information on that property. And then any drawings that are available, but primarily we want to see layout-type architectural drawings and the civil drawings to make sure that we have a pretty good idea of what we’re looking at as far as what we’re going to see inside and out.

Kristin Bailey: Thanks, Conrad. Now we have a lot of clients that have vacation properties. Do you guys ever do cost segs on vacation properties?

Conrad Jennings: Absolutely, and the reason we do is because vacation properties are usually a little more expensive than most, and so the amount of tax basis is usually high enough that we can get an ROI at a decent level to where it makes sense for the fee compared to the actual benefit.

Kristin Bailey: Great. Well, Conrad, thank you for joining us. I just wanted to remind everybody before we log off that real estate losses can be subject to certain limitations. You definitely want to check with your tax advisor before embarking on a cost segregation study. Additionally, the cost segregation study will provide you with the support if the IRS ever audits your depreciation records, so it’s really important to have this support if you are going to take accelerated depreciation on real estate. And that is part of what your cost segregation study vendor, the Jennings-Danovich Group, will provide you with at the end of the engagement. So thanks for logging on and listening and we’ll see you next month, contractors.

Optimize Your Tax Strategy Today

A cost segregation study is a powerful tool for maximizing tax savings and improving your financial planning. If you have questions about how a cost segregation study can benefit your business or need assistance with your tax strategy, our team of experts is here to help.

We can guide you through the process, develop a tailored financial plan, and ensure you’re taking full advantage of all available tax benefits.

Contact us today to start optimizing your financial strategy and secure a prosperous future for your business.