By Phillip Harp, Cost Segregation Services/Northwest Arkansas

If you own a commercial facility, you may be able to gain significant tax advantages by applying a cost segregation study to your building. Cost segregation is a term for an IRS-approved application that maximizes depreciation expense on commercial property and reduces the amount of income tax owed.

The savings can generate substantial cash flow you can use to reinvest in the business, purchase property or equipment, apply to debt service or simply spend as you see fit.

Although not as well known or used in smaller businesses, the benefit of cost segregation is real dollars you keep in your business pocket that would otherwise be paid to the IRS. I tell my clients that by not taking advantage of the rules, you are unnecessarily overpaying taxes. It’s as if you are giving the IRS a generous interest-free loan.

Here’s how cost segregation works: When a building is acquired, it is depreciated in equal increments over 27.5 or 39 years. By identifying and reclassifying eligible assets into the appropriate asset class and corresponding depreciation schedule, owners can increase depreciation on their building. Assets include items such as dedicated electrical, plumbing and excavation work related to parking, landscaped and sidewalk areas, and components of your property that aren’t easily identifiable from an invoice or general contractor’s application for payment.

Tax savings are then realized by accelerating depreciation on all eligible non-structural elements of a building into five, seven, and 15-year schedules.

It doesn’t matter if you’ve owned your building for years. In fact, the IRS allows you to “catch up,” applying any previous missed depreciation in the year of the study. To give you an idea of the average savings, a $500,000 office building acquired in 2004 would generate between $25,000 and $40,000 in increased cash flow to you.

Would that make a difference in the operation of your business? Yes, the resulting savings can be significant.

Doesn’t my CPA take care of this for me? Possibly, if they have construction engineering expertise as well as accounting expertise. Traditional accounting methodologies are acceptable, but do not maximize depreciation expense allowed under the IRS rules. The Journal of Accountancy states, “greater tax savings will be possible with an engineering report.”

Because it is a highly specialized and complicated application, a study should only be performed by those with knowledge and expertise in this field. The IRS states that a cost segregation study should be “performed by ‘qualified’ individuals or firms, such as those employing… personnel competent in design, construction, auditing, and estimating procedures relating to building construction.” (PLR7941002).

A detailed, engineered cost segregation study is generally recognized as providing the most accurate and reliable results. Cost segregation rules may only be applied to commercial buildings. Government and not-for-profit structures are excluded. Virtually any other type of commercial building is eligible, and engineered cost segregation studies have been successfully applied to offices, warehouses, retail, mini-storage, restaurants, hotels, strip malls, medical facilities, apartment complexes, manufacturing and others.

It’s important to choose the right firm. Here are tips for due diligence when selecting a service:

•  Find an established, experienced provider.

• Check their qualifications.

• Don’t be afraid to ask for references.

• Ask for a complimentary analysis that identifies the benefit available and the exact cost to obtain that benefit. Any reputable firm would provide this.

• They should always stand behind their work.

Cost segregation is a specialized and powerful tool that accurately allocates commercial property assets for federal income tax depreciation calculations. Is cost segregation for you? It’s easy and painless to find out. Find a reputable cost segregation specialist and ask them to provide a complimentary analysis for your building. Discuss the results with your tax advisor or accountant. They will apply the results of the study to your tax return so you may enjoy the benefit.

Phillip Harp is a senior account executive with Cost Segregation Services, Inc., one of the leading providers of engineered cost segregation studies in the country. He is a life long resident of Northwest Arkansas. Email your questions to plharp1@cox.net