Cost segregation is the process of identifying personal vs. real property along with individual building components for tax purposes, rather than treating a building as one large asset. This determination allows the owner to depreciate his assets over their useful life.
To see how cost segregation applies to self-storage, let’s answer 10 frequently asked questions regarding this depreciation strategy.
1. Does my property qualify?
All investment properties, including self-storage, qualify for cost segregation. When a cost-segregation study is applied, you’re simply telling the IRS that you’re choosing one approved depreciation method (modified accelerated class recovery system, or MACRS) vs. another (straight line). Both are acceptable, however, MACRS requires an analysis to identify the value of each individual asset you own, rather than looking at your property as one large asset.
2. When does it makes sense to do a cost-segregation study?
Cost segregation can be applied to a newly purchased building, new construction or a building you’ve owned for around 15 years or less. If the property isn’t fully depreciated (39 years is the length of normal depreciation), then there’s an opportunity to change the method with cost segregation. Although any property can be depreciated under MACRS, the cost of performing a cost-segregation study may outweigh the benefits if the property was acquired for less than approximately $300,000.
3. What items are reclassified via cost segregation?
Under straight-line depreciation, a property’s total cost (less an allocation for land) is depreciated evenly over 39 years. Under MACRS, the assets are identified and reclassified in five-, 15- and 39-year class lives, depending on the IRS determination of its actual useful life, along with considerations to whether the assets are used for business or the basic function of the building’s use as a structure.
For example, a 39-year property includes windows, walls, doors, roof, HVAC systems, plumbing and electrical. A 15-year property includes exterior improvements, such as fencing, exterior signage, asphalt, curbs, landscaping and exterior lighting. Five-year properties include carpet, appliances, specialty lighting, woodwork, unit partitions, individual unit locks and security, as well as business-specific heating and ventilation systems.
4. Does the type of property affect the tax savings?
Some property types will have a higher reallocation percentage than others. Interior, climate-controlled self-storage properties will see a higher amount than a shed-row or boat/RV-storage asset. The allocations are based on actual assets and values, or each of the components within the property.
5. What information is required to do a cost-segregation study?
Surprisingly, the information required to perform the study is limited. For a recent purchase, the closing or HUD statement is the only requirement. Blueprints are helpful but not necessary. New construction projects require cost breakdowns, including total costs for construction and development, but individual invoices aren’t required.
6. Will I get audited if I do a cost-segregation study?
Cost segregation isn’t a “trigger” for an audit. The IRS issues automatic consent for deprecation whether applying a change from straight-line or MACRS at the time of purchase or retroactive to a property you bought 10 years ago. This means taxpayers are allowed to make this change with the approved forms offered by reputable cost-segregation firms. However, in the rare case of an IRS review, rest assured that a detailed report with the proper IRS-approved methods and audit support will effectively defend your tax-filing position.
7. How much does a cost-segregation study cost?
The cost is usually based on the type and use of the building, its size, and the location of the property. Beware of cost-segregation providers who charge a percentage of the tax savings. The savings is relative to the entity type, number of owners, the year of acquisition and other factors, so the actual cash benefit can vary. Most providers will offer a quote along with projected tax savings, so you and your accountant have the information necessary to make an educated decision.
8. How much will a cost-segregation study save me?
The tax savings can vary depending on the type of building, your total acquisition cost and length of ownership. Self-storage properties vary in type and size and may see reclassification percentages from 15 percent to as high as 40 percent. Request a detailed benefit analysis from a qualified and experienced firm that has a history with self-storage.
9. What does the Tax Cuts and Jobs Act (TCJA) mean for my tax return?
Passed in December 2017 by the Trump Administration, the TCJA is the largest tax-reform bill enacted in more than 30 years. There are significant changes that offer tax cuts for real estate investors. The largest is the adoption of 100 percent bonus depreciation for tangible personal property acquired after Sept. 27, 2017.
Tangible personal property is defined as assets with a useful life of five, seven or 15 years. When cost segregation is performed to identify the personal property apart from real property (39-year assets), it allows the owner to capture bonus depreciation on the reclassified property and immediately expense the entire value in the year purchased.
10. How do I choose a cost-segregation provider?
Choosing a reputable firm is vital to ensure every aspect of the IRS requirements are met, and in the case of an audit, the report is upheld without disallowances or associated interest and penalties. The IRS Audit Technique Guidelines dictate that a physical site visit is performed, with the analysis provided by a professional who has cost-accounting or engineering expertise. The method of determining asset value must also be an approved methodology.
Make sure audit defense is included in your study and the final report offers complete detail on every aspect of your property. Choosing a low-cost provider may be tempting, but the ultimate savings, detail and support of a reputable provider will far outweigh any additional costs. Also, ask for and check references.
As you can see, cost segregation can be well worth the effort, but make sure you work with a reputable provider who can ensure your tax filings meet all IRS requirements.
Heidi Henderson is executive vice president of Engineered Tax Services, a licensed engineering firm focused on specialty tax services relating to federal tax incentives and strategies for real estate owners. She has more than 20 years of tax and accounting experience in the real estate finance, development, construction and commercial property sectors. To reach her, call 801.689.0325; e-mail [email protected]; visit www.engineeredtaxservices.com.