Cost Segregation Equals Increased Cash Flow
By Steven Everson
Construction/Real Estate Advisor, 2004 Issue No.1

Do you own property purchased in the ‘90s? Are you building, buying, or renovating a new facility? If so, a cost segregation study may bring you substantial cash flow benefits through tax deferrals, cutting the overall cost of constructing, renovating, or acquiring a new building by as much as 10 percent!

How can you benefit?

Through substantially increased cash flow. By allocating building costs to shorter-lived assets, more depreciation can be claimed in the early years of a new facility, thereby deferring taxes otherwise paid. Studies can be completed for new transactions or on any facility acquired in the past — as far back as the early ‘90s. Catch-up depreciation deductions are claimed in the current year. The following are two real-life examples:

• New build of a heavy manufacturing facility — A heavy manufacturer’s business had grown out of its existing facility and decided to build a $3 million plant. By conducting a cost segregation study, the taxpayer was able to reclassify 2 percent of costs to a five-year depreciation period, 50 percent to seven-year property, and 15 percent to 15-year property. The present value alone of the cash flow savings totaled $390,000 – 13 percent of the total cost of the project!
• Purchase and renovation of an existing office building — Cost segregation studies are not limited to industrial facilities. A $10.95 million office building was recently purchased and renovated. Originally built in the 1970s, the building’s costs — such as land improvements, carpeting, wall coverings, special plumbing, millwork, and electrical work — were reclassified to shorter-lived assets. The present value alone of the cash flow savings totaled $435,000 — a 4 percent rebate on the overall cost!

The key to conducting a cost segregation study is combining tax and engineering expertise to determine personal vs. real property, with personal property being depreciated over a shorter life than real property. One critical test is whether the property relates to the overall operation and maintenance of the building. There is a substantial amount of tax law in this area that was developed under old Investment Tax Credit rulings and, in the late ‘90s, the Tax Court agreed with Hospital Corporation of America’s application of these rulings to the cost segregation process. The IRS agreed with the Tax Court’s decision in the HCA case but also said the studies have to be conducted by qualified professionals.

In addition to the benefits noted above, recent tax law changes have given us 30 percent or 50 percent bonus for qualifying assets placed in service after Sept. 10, 2001 and before Dec. 31, 2004. Generally speaking, the bonus depreciation rules apply to new assets that are depreciable over 20 years or less — which means personal property and land improvements would typically qualify for the bonus depreciation.

What kinds of properties make sense for a study?

As noted above, studies can be done for properties placed in service over the last 10 to 15 years, newly constructed buildings, and newly acquired buildings. Examples include manufacturing, retail, processing, office buildings, laboratories, health and long-term care, food services, auto dealers, and hospitality. For businesses that are looking to reduce their tax burden, thereby increasing their cash flow, cost segregation studies are a perfect solution.