You Need To Know About The Cost Segregation Analysis – Part 2
Last month, I discussed cost segregation analysis; what it is and why it would be advantageous for a commercial building and sometimes a residential rental property. If you missed part 1 of this 2 part series, be sure to go back and check it out.
Cost segregation studies are used to determine the allocation or reallocation of the total cost of the property into different property classes and recovery periods. This is important in order to properly compute depreciation deductions.
This study takes different components of your building and identifies them so they may be deducted under a different asset class with shorter recovery periods. This equates to a larger depreciation deduction and opens the door for other, more aggressive depreciation methods.
It is important to note here that it’s not as simple as you making an assumption and arbitrarily assigning a value to certain components of your property. This would likely not pass an IRS examination so the methodology used is critical for an accurate cost segregation study.
A cost segregation analysis is generally performed for either newly constructed property or acquired property but, each of these situations require a very different approach.
Newly constructed property, which includes remodels and additions to existing properties, usually involves construction that was completed relatively recently. The cost seg is typically performed either at the completion of the construction project or shortly after.
Direct cost information from contractors, vendors or other suppliers and indirect cost information from Architects, Engineers and other professional firms should be readily available. Also, construction documents that were used for the project such as construction drawings, specifications and contract documents are generally readily available as well and are used in the detailed engineering approach. According to the IRS’s audit technique guide, this method is the most methodical and reliable approach but it’s not the only approach.
The IRS includes a list of the most common approaches utilized for cost segregation studies in their audit technique guide. This guide is used by IRS auditors in the case of an examination.
So what about the purchase of an existing older building? In this case, cost and construction information may or may not be readily available. When construction cost information is not available, it has to be reconstructed using the construction cost data, methods, and techniques normally used for property appraisals.
The reconstructed cost is then adjusted for the current physical condition of the property at the time of acquisition and finally adjusted to match the actual amount paid by the taxpayer for the property.
If you have a tax or accounting question, visit my website to find more educational resources.
Read Want To Write Off Your Commercial Building or Rental Property Faster? What You Need To Know About The Cost Segregation Analysis! Part 2 and the other informative articles in this issue of Soar to Success magazine.