What is Cost Segregation?
Cost segregation is a highly beneficial and widely accepted tax compliance strategy utilized by commercial real estate owners and tenants to accelerate depreciation deductions, defer tax, and improve cash flow. Once used only by large accounting firms type accounting firms and the nation’s largest real estate owners, this practice has now become routine for commercial property owners of almost every size.
Cost segregation is considered one of the most effective tax strategies for real estate owners and investors and is one of the top niche services for accounting firms. You may be leaving serious tax benefits on the table by not using it. It’s not just for newly constructed or newly acquired assets and it can dramatically increase your cash flow.
What is a Cost Segregation Study (CSS)?
A cost segregation study is an engineering-based analysis of all buildings, improvements, and land improvements. It classifies costs into correct MACRS recovery periods and maximizes and supports accelerated depreciation. If performed correctly, it’s recognized by the IRS as an accepted procedure. If performed incorrectly, you can open yourself up to scrutiny from the IRS and potentially face an audit. Picking a quality firm can help save you a lot of time and money in the long run.
The timing of the cost segregation study is important. Performing the study at the wrong time can wipe out the benefits. A cost segregation study should be performed immediately after construction or acquisition, following major capital improvements (including leasehold), after a change in ownership, or buildings already in service. For buildings already in service, a Look-back study must be performed.
What is a Quality Cost Segregation Study?
In 2004, the IRS released the Audit Techniques Guide (ATG), giving some guidance and insight into what they are looking for.
According to the IRS, “A quality study identifies the preparer and always references his or her credentials, experience and expertise in the cost segregation area.” A quality study provides the documentation needed to defer substantial tax payments and greatly improve cash flow. It is important to note that a cost segregation study does not create new deductions but increases deductions in the early years of ownership. This front-loading of depreciation allows the taxpayer to take advantage of the time value of money.
The IRS also says a “quality” study needs to be performed by “qualified” individuals. Qualified individuals are engineers or others competent in design, construction, and costing procedures relating to the building construction.
One of the most significant developments in recent years came from the American Society of Cost Segregation Professionals (ASCSP). In 2009 the ASCSP introduced the first set of industry standards and the first ever professional certifications for cost segregation professionals. Selecting a firm which has employees who are Certified ASCSP members is an important consideration.
Why is it Important to Pick a Quality Firm?
Per the IRS Audit Techniques Guide, studies being performed by unqualified individuals and those using an abbreviated methodology will receive higher scrutiny than the ones performed by qualified professionals who utilized the detailed engineering-based approach. Therefore, it is more important than ever to have your studies performed by an expert in the field.
What to Look for when Evaluating a Cost Segregation Provider
When evaluating a cost segregation provider, there are several things you should look for. First, you want to figure out how long the firm has been performing cost segregation studies and how many studies they have performed. Next, you want to figure out if the firm employs degreed or professional engineers and tax experts with specific cost segregation experience. You should also ask the firm if they employ any ASCSP Certified Cost Segregation Professionals and if so, what role do they play.
When it comes to the study, ask the firm if they use a detailed engineering approach and if they comply with ASCSP standards. It’s also important to know if the firm subcontracts their cost segregation studies to a third party and if they carry professional liability insurance. And finally, you need to ask the firm how they defend their work in the event of an audit. You can also ask for references if you are still on the fence.
The Importance of the American Society of Cost Segregation Professionals (ASCSP)
The American Society of Cost Segregation Professionals (ASCSP) has been established as a non-profit corporation in response to the growing need for education, credentials, technical standards and a Code of Ethics within the cost segregation industry. The ASCSP was created to provide organizational oversight on an industry where there was none.
The Source Advisors Approach
Our cost segregation services are designed to exceed the IRS’ Cost Segregation Audit Techniques Guide’s Chapter 4-Principal Elements of a Quality Cost Segregation Study and Report. Every Source Advisors study begins with our detailed pre-qualification process where the scope of work is defined, and an estimate of benefits is generated. A flat fee quote is also presented with the estimate of benefits.
Once the proposal is signed, our team will gather and analyze information provided by you, such as: Construction drawings, invoices, change orders, depreciation schedules, etc. From the invoices, we will identify any property that might be specifically reclassified. In the likely event that the invoice detail is insufficient for the entire study, we will augment the invoices with detailed estimates derived from the construction drawings and site visit of the property. The results will be presented in a report that includes our methodology, relevant case law, definitions, property description, photos, and detailed schedules of our calculations.
Each study is reviewed a minimum of three times to ensure accuracy and quality. A draft report is first issued, and discussions are held with the taxpayer and their CPA to verify Source Advisors assumptions and findings. Once all questions have been addressed and adjustments made to the report, the final report is issued. In the event that a study is reviewed in audit, Source Advisors’ highly experienced management team will provide audit support through appeals.