Cost segregation minimizes the ever increasing tax burden of our real estate holdings

Property owners are tapping into cost segregation studies to accelerate depreciation on real estate holdings-and reap significant financial rewards. Each week when I get around to reading my tax newsletter, the conclusion is the same. Federal and state taxes are going up at an alarming rate. Whether it is in the form of limiting deductions or outright bracket increases, we are all going to be digging deeper. However, one way to reduce the tax burden is through the use of accelerated deprecation on real and personal property improvements using a cost segregation study (CSS). A CSS is an IRS-approved process that allocates capitalized costs to their correct recovery period. Done properly, a CSS can help reduce taxes and increase cash flow. Furthermore, a CSS can be applied on a retroactive basis (no amended returns required) or for recently acquired assets. The outcome of this process is often tax savings totaling in the hundreds of thousands of dollars. If you think that's good news, consider this: the increase in annual after-tax cash flow through accelerated depreciation can be retroactively applied to your portfolio of assets all the way back to 1987. The key to success is an engineering-based approach that includes multiple disciplines for maximum results. The IRS has issued specific guidance that requires the education and experience of an engineer, architect or other construction professional that understands construction means and methods. The construction professionals position must be complemented by a professional with knowledge of capitalization requirements embedded in the tax code to ensure that the correct categorizing of the improvements. In short, the IRC in most circumstances looks to how buildings and their improvements are constructed in their determination of whether an item is either real or personal property. Understanding accelerated depreciation Real estate improvements are typically depreciated using a straight-line method that runs over a 27.5-year period for residential properties and a 39-year period for non-residential properties. What you may not know is that the tax code, in conjunction with relative procedures and rulings allow certain tangible building components and improvements, as well as a wide range of site work costs, to be depreciated over a much shorter period-15, seven, or even five years. That's where the CSS comes in. The CSS is a strategic weapon in the real estate owner's tax saving arsenal because it identifies these shorter-lived assets. In short, ownership has a choice. Recover the depreciable basis over a period of two or more decades, or substantially reduce the weighted average recovery period through the use of a CSS. Here's how it works All costs, both direct and indirect, associated with new or existing construction are scrutinized. Those costs are then classified as real or personal property. Certain elements of improved real and personal property are then depreciated on an accelerated basis. Realizing potential cost savings How significant? Of course, the actual amount of the real savings and financial benefits vary. The type of property, its age and specific construction components are key considerations. That said, most facilities can derive some benefit. On average, real estate owners can increase an after tax IRR by 100 basis points or as much as 350 basis points on a cash-on-cash basis. Prime CSS properties Property owners could expect an average of 15-30% of project-related costs to be reclassified into shorter-lived categories. The more specific function-dedicated a property is, the greater the potential benefit. Manufacturing facilities, hotels and resorts, and corporate headquarters, as well as high-end tenant improvements, are CSS candidates. Properties with extensive site preparation work and personal property, such as big-box retailers, warehousing and distribution centers, self-storage facilities, and multi-family buildings are also excellent CSS candidates. Key Questions Did you construct, acquire, renovate, or improve your property after 1986? Is it currently under construction? Do you expect to hold the property for at least three more years? Can you utilize additional depreciation to help reduce taxable income? If you answered "yes" to these questions, the fifteen minute call with a qualified CSS professional may save you a substantial sum of money. How do I find a qualified CSS provider? There are many cost seg providers. But not all are created equal. If you do not have the financial strength to use one of the "big 4 accounting firms," who do you choose? The American Society of Cost Segregation Professionals is a national society focused on continuing education, certification, and minimum quality standards to assist taxpayers and their professional advisors with making informed decisions on the selection of qualified cost segregation providers. Gaining the maximum financial benefits from CSS-and passing muster with auditors-means working with a firm that has experience navigating the labyrinth of rules, regulations and opportunities presented by accelerated depreciation strategies. The bottom line is cost savings that go far beyond the investment in the study. Mark de Stefanis is the president of Construction Cost Recovery, White Plains, N.Y.