A cost segregation study categorizes the component parts of a commercial property for tax purposes, which allows the owner to optimize depreciation claims. A textbook cost seg analysis takes place not long after a property is acquired or a new building is completed, so the owner can begin taking full advantage of depreciation in the first years of ownership. In the storybook version, the owner has all the records neatly organized and completes the process in the right sequence.
For every cost segregation study that neatly conforms to textbook expectations, there are a dozen others with challenging wrinkles. Too many businesses lose out on the benefits of cost segregation analysis because they assume their case is outside the bounds of the textbook example. But analyzing a property with messy records and a complicated tax history can still create substantial benefits for the owner.
Here’s a great example of a project Whittaker & Company completed in a scenario you won’t find in the textbooks.
Early mistakes can cost a business
A Whittaker & Company client owns hotels. They bought an existing building for $9 million and put over $1 million more into renovating the property after the deal closed. Straight away, the business made some mistakes:
- They allocated the full purchase price of the property among its existing assets and, as a result, claimed large depreciation deductions without having adequate backup.
- During the renovation process they didn’t keep track of which assets were replaced. Instead, many replaced assets were left on the fixed asset schedule and continued to be included in the business’s depreciation claims. Instead, the company could have realized many of these losses in the year of the renovations.
- The business waited almost two years before engaging Whittaker & Company to perform a cost segregation study. In that time they had filed a tax return, which included depreciation deductions for the newly acquired hotel using asset categories that left significant tax benefits on the table.
In a typical cost segregation study, much of the value comes from classifying assets so they qualify for faster depreciation than would be the case if they were bundled with the building itself. Many assets that can be classified as personal property can qualify for bonus depreciation in the early years of ownership.
In this client’s case, that value was diminished because they had already claimed a year of depreciation on incorrectly classified assets. As a consequence, the client had already lost out on a sizeable portion of the bonus depreciation that would otherwise have been available for the hotel’s equipment and furnishings.
Recovering from mistakes with cost segregation analysis
Nevertheless, the cost segregation analysis resulted in a significant advantage for the client. A cost seg study provides an exceptionally detailed schedule of assets. Using the schedule of assets from the study, the client could at last identify the assets that were removed during renovations. The savings from this piece alone were over $1 million. Because the report was exceptionally detailed, the business could also rely on it as support in the event of an IRS audit.
Together with other deductions identified during the course of the study, the client was able to make a deduction of about $1.8 million—on a $9 million purchase. We estimate that if the client had conducted the study in the year the building was acquired, they might have saved an additional $400,000 to $500,000.
The lesson for other commercial real estate owners is this: don’t be discouraged if your cost segregation study wasn’t conducted right away, or if your records are a mess. With proper techniques, an analysis can still yield substantial tax savings.
Whittaker & Company is your resource for cost segregation analysis
If your business is thinking about buying property or building new improvements, we strongly recommend exploring the potential savings that can come from cost segregation analysis. We’ve put together an information sheet that goes into more detail about cost segregation and its advantages. You can find it here.
The team at Whittaker & Company is proud of the value it has delivered for its cost segregation clients. We’re happy to discuss your circumstances to determine whether a cost seg analysis is right for your business. Reach out to us to start a conversation.
Tax returns, financial statements, IRS communications and similar items are vital to address and process, but they should not be the focal point. Think of these as tasks to get to the real work, which is providing you the information you need and an interchange of ideas to move you forward. The goal is to help you implement your strategies and vision. This is what we do!