Monday, May 14, 2012

Tax Savings on Income-Producing Properties

Cost Segregation Studies could save Sacramento and Northern California business owners thousands, even hundreds of thousand of dollars in taxes if they own their facilities. Most of these business owners, however, don't seem to know about these studies. Why do I say that? Because every time I mention the advantages of a Cost Segregation Study to an owner of income-producing facilities, whether in Sacramento, Stockton, San Francisco or Yuba City, I get a puzzled look, the same look you might get if you asked for a "pop" in San Francisco. Or sometimes I get that other puzzled look, the one that means, "I think I've heard of that... but I'm not sure what it is... and I'm not sure it's a good idea for my facility."
I'm here to tell you, folks: In most cases, a Cost Segregation Study, or CSS, is a good idea for your facility.
Have you, at any time since 1986 constructed, purchased, expanded, or remodeled any kind of income-producing real estate, such as such as manufacturing, industrial, research labs, financial institutions, office buildings, hotels, retail stores, apartment complexes and shopping centers-even a single family rental unit? Yes? Yes! Then you could benefit.
The Journal of Accountancy will only go so far as to say that CPAs should routinely recommend CSS to their clients "whenever the expenditures for an acquisition, including leasehold improvements, equal or exceed $750,000," but the fact is that a lot of folks who have spent considerably less can also benefit.
Why, just last summer, I worked up a Cost Segregation Study for a friend of mine in Yolo County who had purchased a little beach rental in 1997. We uncovered about $30,000 in unused depreciation. He told me later that his CPA / Tax Preparer converted the data into about $7,000 in tax savings-for the current year! And his condo did not cost him nearly $750,000.
In another instance, I did the math for a Sacramento area office complex in which the Cost Basis was $831,000. We moved about $200,000 of that to short lived depreciation. At a 30% tax rate that is $60,000 in tax saving! This smart businessman used the CSS as part of the cost benefit analysis to determine whether buying the complex would actually pencil out as a profit.
By now I hope you're asking yourself, "What is this marvelous tax-savings tool called Cost Segregation Study and how can it help me increase my cash flow through accelerating depreciation?"
Here's the short story: While it's best to complete a CSS in the year the building or improvements are placed in service, these studies can also be done retroactively, just as we did on the beach condo mentioned above. The IRS calls this a Change in Accounting Method (IRC 481(a) adjustment) and increased tax deductions are made in one year without amending prior year returns. Studies can reach back to 1987 and prior returns are not amended. A Cost Segregation Study can be performed on any property constructed, acquired or remodeled since January 1, 1986. Even if you no longer own the facility. Think about that for a minute...
Generally, 20% to 55% of building costs can be reclassified to shorter depreciable lives. The key for a solid Cost Segregation Study that your CPA / Tax Preparer and the IRS will accept is that an Engineering Study must be included, which any reputable CSS preparer will be sure to do. Make sure this a part of any agreement you might sign.
But how, exactly, you may still be wondering, does a Cost Segregation Study work?
A CCS analyzes property costs to segregate allowable short life assets from longer life Real Property costs. It's an IRS-approved method of re-classifying certain components and improvements of a commercial building from real to personal property. This process allows the assets to be depreciated on a five-, seven- or 15-year schedule instead of the traditional 27.5- or 39-year depreciation schedule of real property.
A CSS can also provide other benefits, such as the ability to write off the entire remaining tax basis of a building component upon replacement. An article in the Journal of Accountancy gives this example:
"... Suppose a cost segregation study showed the initial value of a roof to be $500,000. Two years later, when the roof has an adjusted tax basis of $480,000, it needs to be replaced. The taxpayer could deduct a $480,000 loss. Had the taxpayer not done the cost segregation study, the outcome would have been vastly different; no loss could be taken because the roof's tax basis and the basis of the building would remain intertwined."
Cost segregation is a tax-planning tool that all owners of income producing properties should be using. Sure, back in the beginning, only multi-million dollar companies could afford them, but that's not true anymore. Studies are now so affordable that they make smart business sense for almost everyone--even folks who own only one single-family rental.
Oh, yes, it's true that even without CSS, facility owners would eventually benefit from the depreciation, after a few decades, assuming the building is not sold and that the owner doesn't die. Well, it happens. But why wait? A Cost Segregation Study NOW could give you an interest-free loan from the government for the first 15 years, which you will then repay interest-free over the remaining 25 years. If you like the sound of that, talk to your CPA.
Jack Young provides tax-saving Cost Segregation Studies for income-generating properties. He is a CPA, an Accredited Senior Appraiser (ASA) of the American Society of Appraisers specializing in machinery and equipment and has a Graduate Personal Property Appraiser (GPPA) designation from the National Auctioneers Association. Jack is the Co-Discipline Director of the Machinery and Technical Specialties Committee and the Chapter Secretary of the Northern California Chapter of the ASA.