Cost Segregation Study
What is a Cost Segregation Study?
The goal of a Cost Segregation Study is to identify building costs that have been
traditionally depreciated 39 years and to re-allocate a significant portion of these
costs to a shorter, accelerated method of depreciation. Additionally, they
can be used to identifying improvements that may qualify for the 50% bonus depreciation
and allocating hard and soft costs to these improvements.
Construction-related costs, which may account for as much as 75 to 90 percent of
the overall project cost, are usually lumped together as real property with a depreciable
life of 39 years. When segregating the costs of a construction project, it is easy
to properly identify costs of equipment, furniture and fixtures, and computer equipment
that can be depreciated over 5 and 7 years for tax purposes.
Benefit vs. Costs
Reclassification of costs from real property to personal property may:
- Reduce tax lives from 39 years to 5 to 7 for assets such as such as removable carpeting
attached with latex adhesives, signage, movable and removable partitions, cabinets
and shelves, decorative millwork, window treatments, interior ornamentation, certain
electrical and plumbing equipment necessary for the operation of specialized equipment
such as computer rooms (rather than for overall building maintenance and operation)
or lighting fixtures that are used for decoration or plant growth.
- Identify leasehold improvements that qualify for 50% bonus depreciation. These
are improvements that are not for the cost of building enlargements, elevators or
escalators, structural components benefiting common areas, or a building’s internal
Structural components for these purposes are defined as load-bearing internal
walls and any other internal structural supports, including the columns, girders,
beams, trusses, spandrels and all other materials that are essential to the stability
of the building.
Generally 10%-25% of the total cost may qualify for reallocation of costs into shorter
tax lives. In most cases, tax saving for the first year will greatly exceed
the cost of doing the study.
Candidates for Cost Segregation Studies
Commercial properties with construction cost or purchase price over $1million.
New construction or remodels/ rehabilitations after 1986
Lessees with leasehold improvements
Improvements with special equipments such as a computer room, a technology demonstration
room, or a special lab.
Properties with cost lower than $1million, or planned to be sold in 2 years are
not good candidates for a cost segregation study.
Timing of Cost Segregation Study
The best time to have a study completed is for the year the building or improvements
are placed in service. During the process, considerable amounts of design
or architect fees may be appropriately identified with certain equipments layout,
non-structural improvements and be classified as properties of shorter lives rather
than be lumped together and allocated to building. Specific identification
is important since the IRS does not allow a simple percentage method for breaking
out construction costs.
A qualified professional such as an appraiser, engineer, architect or construction
estimator should complete the cost segregation study using specific take off and
historical unit cost information as a basis for reallocating costs. Although accountants
are not qualified professionals, they can assist the engineer or architect in the
determination of property that qualifies for shorter lives.
The process includes:
Physical inspection of the property.
Examination of architectural/engineering drawings and specifications for potential
Analysis of cost data, including the contractor’s application of payments, change
orders, owner-incurred costs and indirect disbursements.
Preparation of an itemized list of property qualifying for shorter-life classification
based on relevant income tax authorities.
Apportionment of direct labor, material components and indirect costs based on engineering
drawings and specifications.
Reconciliation of total costs per the engineering analysis to capitalized project
Documentation of methodology, procedure performed and conclusions to provide a clear
and detailed audit trail. A report of the study generally includes a project cost
reconciliation, cost detail and summary by appropriate IRS class lives, property
definitions, study procedures, photos, and final results of facts to be used for
income tax purposes.