Cost Segregation Services
Cost Segregation Services
Why CVA?
When segregating value to acquired assets for federal tax purposes, the valuation skills of the consultant are critical. Many cost segregation specialists are not certified valuers. While it may not be critical for new construction, it is inadequate for the analysis of acquired property. Our cost segregation team includes certified and credentialed valuers who have analyzed similar projects to yours along the life cycle of real property, from development to demolition.
A significant gap in the rates of depreciation between real and personal property exists, which affects income taxes. Most real property is depreciated for 39 years while most personal property is depreciated over 5 or 7 years. Often items that can be classified as personal property for tax purposes are misclassified in the cost of a building’s construction cost and, are therefore, being depreciated as real property. This misclassification costs the property owner valuable tax benefits due to a much longer depreciation period for real property. The net after-tax present value of properly categorizing and depreciating an asset as 5 or 7 year personal property rather than 39 year real property is substantial.
Cost segregation is the comprehensive analysis of all costs associated with a construction project or building acquisition with the objective to maximize depreciation benefits by segregating and documenting the cost of all short-lived property identified as part of the capitalized cost of the project. The intent is to break out as much Section 1245 (personal) property as possible from what otherwise would be classified as Section 1250 (real) property.
Corporate Valuation Advisors performs cost segregation studies of new construction and acquisitions of real property, as well as of past construction projects and acquisitions. Retrospective studies may be relevant due to a company coming out of a net operating loss position or improper classifications of the real property. In these situations, the depreciation adjustment can be fully recognized in the first year, through submission of Form 3115, Application for Change in Accounting Method, significantly increasing cash flow.
Benefits to the Taxpayer
What is the present value of accelerating depreciation and deferring taxes?
- For every dollar of cost shifted from 39-year to 5-year property, the present value tax benefit is approximately 14 cents.
- For every dollar of cost shifted from 39-year to 7-year property, the present value tax benefit is approximately 13 cents
- For every dollar of cost shifted from 39-year property to 15-year property, the present value tax benefit is approximately 8 cents
*Assuming 25% combined tax rate and 8% discount rate
Revenue Procedure 87-56, as modified by Revenue Procedure 88-22, provides a complete list of class lives and recovery periods. Under the Modified Accelerated Cost Recovery System (MACRS) property classes are established by Internal Revenue Code Section 168(c). Under the general MACRS rules, property is classified based upon the property’s class life unless a different recovery class is assigned under IRC Sec. 168(e)(2) (residential rental and nonresidential real property). The five most widely used periods are 5, 7, 15, 27.5, and 39 years.
5-Year Property
Computers
Office Machines
Autos and Trucks
Retail Tangible Personal Property
7-Year Property
Office Furniture and Fixtures
Personal Property not Classified Elsewhere
15-Year Property
Depreciable Land Improvements,
e.g., Sidewalks, Fences, and Roads
Retail Motor Fuel Outlets (subject to restrictions)
27.5-Year Residential Rental Property and 39-Year Nonresidential Property
Most “building” Section 1250 property
| 3-year class | Personal property with an ADR midpoint of 4 years or less |
| 5-year class | Primarily personal property with an ADR midpoint of more than 4 years, but less than 10 years |
| 7-year class | Primarily personal property with an ADR midpoint of at least 10 years, but less than 16 years, and property that is not specifically assigned to any other class |
| 10-year class | Property with an ADR midpoint of at least 16 years, but less than 20 years |
| 15-year class | Property with an ADR midpoint of at least 20 years, but less than 25 years |
| 20-year class | Property with an ADR midpoint of 25 years or more |
| 27.5-year class | Residential rental property |
| 31.5-year class | Nonresidential real property (pre-Omnibus Budget Reconciliation Act of 1993) |
| 39-year class | Nonresidential real property (post-Omnibus Budget Reconciliation Act of 1993) |
Real (Section 1250) or Personal (Section 1245) Property?
- Property Permanence—Whiteco Industries, Inc., v. Comm’r (six point test)
- Is the property capable of being moved, and has it in fact been moved?
- Is the property designed or constructed to remain permanently in place?
- Are there circumstances that tend to show the expected or intended length of affixation, may the property have to be moved?
- How substantial a job is removal of the property, and how time consuming is it, i.e., is it “readily removable”?
- How much damage will the property sustain upon its removal?
- What is the manner of affixation of the property to the land or building?
- Building v. Accessory to the Taxpayer’s Business
- Does the property serve no more than an incidental relationship to the operation or maintenance of the building?
- Relation to Machinery and Equipment
- Is the property inextricably linked to specific equipment, or is it reasonably adaptable to more general uses?
ONE THING IS CLEAR – THE FEDERAL INCOME TAX LAW IS UNCLEAR REGARDING THE DISTINCTION BETWEEN PERSONAL AND REAL PROPERTY
What We Do
Processes employed by our cost segregation engineering team follow standard professional engineering and cost estimating methodologies, including:
- Review of the blueprints and specifications to identify potential shorter-life assets
- Inspection of the facility to understand its nature and use, and to gather further information supporting appropriate class life allocation
- Review of the general contractor’s application for payment (G702 & 703, Schedule of Values) and change orders, along with other project cost information, to identify potential short-life property
- Performance of quantity take-offs and cost estimates for personal property identified but not segregated in the project cost information
- Allocation capitalized indirect or “soft” costs to the appropriate direct cost category
- Preparation of a property unit listing describing identified assets by cost category and appropriate MACRS class life reconciled to the total capitalized cost of the facility
- Issuance of a final report summarizing our analysis and findings including property unit schedules with appropriate MACRS class lives
The above are applicable to both new and purchased properties. For a purchased property, we offer the option of performing a qualified appraisal of the underlying land.
The methodology outlined previously provides the basis for all cost segregation analyses. The makeup of your real estate portfolio will determine which method below is used. The goal of each approach is to maximize your cost segregation objectives:
Our engagement process involves:
- Conference call or meeting to determine project scope and timetable
- Performance of benefit analysis (if requested) to provide a preliminary estimate of NPV tax savings
- Preparation of a formal proposal/engagement letter
- Request of specific data after authorization to proceed
- Scheduling and completion of conferences/meetings and property inspection
- Delivery of conclusions in an electronic report, or as agreed to in the engagement letter
The methodology outlined previously provides the basis for all cost segregation analyses. The makeup of your real estate portfolio will determine which method below is used. The goal of each approach is to maximize your cost segregation objectives: