Properly executed cost segregation studies have the potential for significant tax savings

Traditionally when an investor acquires a piece of real property the accountants determine the allocation between land and building and calculate depreciation on the building; however, a tax court decision has changed this approach for the depreciation of certain costs related to real property. In the case known as Hospital Corp.of America (July 24, 1997), the court held that certain items in a building may qualify as tangible personal property and therefore these items are not considered real property. The result is a portion of the purchase price may be eligible to be depreciated over a much shorter life that the normal 27.5 or 39 year lives for residential and commercial real property. The court agrees that depreciation over shorter lives would apply to property that would have qualified as tangible personal property under the investment credit rules in effect prior to 1981. This definition excludes property that is either "inherently permanent" or a "structural component" of a building, both of which are considered real property. Whether property is "inherently permanent" is based on facts and circumstances for the particular property. Factors to consider include, is the property capable of being moved, has it in fact been moved and how is the property attached to the land. The term "structural component" includes parts of the building such as walls, floors and ceilings including permanent coverings, windows and doors, all elements of central air conditioning and heating systems, plumbing and plumbing fixtures, stairs, escalators and elevators, sprinkler systems, fire escapes and other components relating to the operation and maintenance of the building. In addition to the building, the property may contain other elements that will qualify for a shorter depreciable life. Items such as land improvements, noise abatement and retaining walls, parking lots and signage will all qualify for special treatment under the MACRS depreciation system. The methodology for determining that portion of the property that qualifies for the shorter lives is known as a cost segregation. A cost segregation study requires an inspection of the property, and a review of the acquisition documents, architectural drawings of the structure and other documentation related to the operation of the property. A thorough study will require the use of qualified engineering/appraisal professionals. Many companies have surfaced to promote this service and their marketing letters promise significant tax savings. Very often these promotions come from accounting firms that do not have the engineering/appraisal skills required for the project. A proper cost segregation study should be completed by an accounting firm that has significant experience in real estate accounting and tax issues and that works in conjunction with engineers and appraisers who are experienced in identifying all the elements of a property. The benefits of cost segregation are not limited to new acquisitions, owners of properties acquired several years ago may complete a cost segregation study now and avail themselves of the benefits on their current tax return. In the end, with the proper selection of qualified professionals, the client receives a cost segregation study with a depreciation calculation having the potential for significant tax savings. Sandy Klein, CPA, is a partner at Shanholt Glassman Klein Kramer & Co, New York, N.Y.