Cost segregation services can deliver significant tax savings, but the businesses that provide cost segregation studies can vary widely when it comes to qualifications and quality. Here are some guidelines to help you choose wisely.
A cost segregation study breaks down a building into component parts in order to properly depreciate separate assets within the property that depreciate more quickly than the overall structure. The standard depreciable life of a commercial building is 39 years. Things like carpet, wiring, cabinets, decorative lighting, wallpaper, furniture, certain mechanical, electrical, and plumbing components, and a host of other items within the building can be depreciated over periods less than 10 years, resulting in significantly higher depreciation deductions during the early life of the building.
Given the amount of work involved in cost segregation analysis, it typically makes sense to consider the process any time a business is spending $1 million or more to build, buy, renovate, or expand commercial property. A cost segregation study requires extensive analysis of a variety of documents, as well as physical inspection of the site. Providers must be able to understand everything from blueprints to contractor invoices and appraisals in order to determine and document the value of the assets within the building that qualify for accelerated cost recovery. Because this process involves such a broad range of expertise across a wide range of disciplines such as engineering, construction, accounting, and tax, businesses that are considering a study should carefully evaluate potential providers. Here’s a discussion of several qualities to look for in a cost segregation professional.
Experience is much more than “How many cost segregation studies have you done?”
Probably the first thing that comes to anyone’s mind when looking to hire someone for any job is, “How many of these have you done before? Do you have references?” Those are certainly good questions to start with when it comes to cost segregation, but they don’t begin to adequately measure the depth of experience needed to do the job right. Cost segregation providers need to demonstrate that they have experience in performing studies and the longevity to be around in the event that tax authorities question your study results several years down the line.
In addition to the firm’s experience, the composition of the team that performs the study must be considered. These studies require a unique blend of engineering and construction expertise with tax and accounting knowledge. A cost segregation provider should include construction and engineering professionals and CPAs who can analyze the building components and correctly classify them under the tax code. One area where tax expertise contributes significant additional savings in the current environment is sustainability incentives. While a provider focused only on cost segregation might identify solar panels, geothermal features, and other green energy improvements as eligible for accelerated depreciation, an integrated team of engineers and tax professionals will recognize that these assets may also qualify for tax credits resulting in significant additional savings. They should be able to aid you in claiming the maximum amount of these credits.
These studies require a unique blend of engineering and construction expertise with tax and accounting knowledge.
The last component of experience to consider is the completion of cost segregation studies in relevant industries. These studies are effective in segments like multifamily living units and retail centers, offices, auto dealerships, senior living, manufacturing, hospitality, and stadium facilities. It’s not enough for a cost segregation firm to have simply done a lot of studies. The firm needs to have experience that’s relevant to the taxpayer.
What’s a cost segregation methodology, and why does it matter?
Businesses that are looking for a cost segregation provider need to understand the value of a thorough and complete analysis that an engineering approach delivers as opposed to the more superficial results of an invoice approach methodology. An invoice approach calculates the accelerated depreciation amounts based strictly on costs that appear on invoices. As a result, taxpayers may miss out on significant tax benefits that could be available if overall costs were examined more thoroughly.
The engineering approach relies on more extensive knowledge of building engineering and tax rules to examine a variety of costs that aren’t broken out on invoices and support estimated values for components that can be depreciated more quickly. It’s a more involved approach that reports back on things like linear feet of wiring or countertops and other pieces that might not be priced out separately on invoices. Businesses that are willing to invest time and money in a cost segregation study are likely to find that the engineering approach will document and support more accelerated depreciation deductions than the invoice approach.
In order to realize the potential benefits of the engineering approach, a provider should also be able to demonstrate effective integration of technology in their review processes. Utilization of state-of-the-art software will enhance the accuracy and efficiency of cost segregation studies and will also deliver more effective documentation to support the calculations if they are challenged by the IRS.
How much does a cost segregation study cost, and what’s included in the fee?
The fee for a cost segregation study varies with the complexity of the property that’s being analyzed. Some providers charge a contingent fee based on the tax savings they identify through accelerated depreciation deductions, but this can result in significantly higher fees for certain properties. Businesses that are considering a cost segregation analysis should work with their provider to agree on a fee based on the amount of work required to perform and document the analysis.
The fee for a cost segregation study varies with the complexity of the property that’s being analyzed.
When working out the terms of a cost segregation service agreement, businesses should also set out clear requirements for communications and timelines. For shorter projects, updates with interim invoices might be sufficient. Longer projects might require the scheduling of quarterly check-ins to explain progress. And all cost segregation studies should be undertaken with a clear understanding of tax filing deadlines and the importance of completing the work in time to reflect the information on the client’s next tax return.
Some providers will offer “free” audit support if the deductions are ever challenged by the IRS, but this can be a bit of a red herring. The best audit support is a cost segregation report that thoroughly and accurately documents depreciation calculations that are reasonably defendable under the law. If a cost segregation provider’s team doesn’t include knowledgeable tax professionals in the preparation of the report, there won’t be much to defend in the event of an audit.
What qualities define a good cost segregation provider?
In closing, perhaps the last thing to mention is the types of comments that show up in client testimonials for a quality cost segregation provider. First, if the provider is unable or unwilling to share recommendations from previous clients, then it’s best to keep looking. For those that do provide reviews, clients should commend:
Their professionalism.
The thoroughness of their work and the report that they provided.
The tax savings that resulted from the study.
For any business considering a cost segregation study, these are the standards by which potential providers should be measured.
