Cost segregation is becoming increasingly popular. One of the main reasons is tax reform. In this post, we want to highlight some of the tax law changes and provide a basic cost segregation template. You can then use it with excel or any other spreadsheet application.
Cost segregation is a technique where engineers and tax experts reclassify costs of parts of a real estate to personal property or land improvements in order to shorten their useful tax lives. Cost segregation has been beneficial to real estate investors in that it increases cash flow and provides a favorable return on the cost of the study.
But in addition to taking a look at a cost segregation template, we wanted to look at an example. The property is actually a commercial building (which we don’t do). But we wanted to use this building to demonstrate the power of cost segregation reports.
First, let’s take a look through the cost segregation process:
- Gather the necessary basic information about the specifics of the property and understand the owner’s tax situation and motivation
- Prepare a projection and illustration of the expected accelerated depreciation and include an estimate of the net present value of the tax benefits
- Evaluate the actual and estimated costs and discuss with owner
- If a study is proceeding, gather final construction drawings, land and building specifications and any related cost data
- Perform a site visit to verify condition and drawings
- Take property photos and gather further information
- Prepare and deliver the final client report
Planning to Increase Personal Property Deductions
Remember, under the tax law, there are three sets of criteria to determine if a property is 5-year personal property versus 27-1/2 or 39 year real property – Movability, Accessory and Function. These are briefly explained:
- Movability – If you can move the component without adversely affecting the building structure or the component is not essential to the function of the building, then most likely it’s personal property. Moveability is the primary requisite in classifying an item as 5-year personal property instead of 27-1/2 or 39 yr. real property.
- Accessory – If certain assets are directly related (accessory) to the operation of a business, they can be considered personal property even though they may be considered fixtures (real property) under local law.
- Function– If an asset “functions” as machinery or equipment, even a structural component can be personal property even if permanently attached.
An asset or component may qualify as tangible personal property under more than one criterion (movability, accessorial, or function). Each criterion should be recognized as support for the preferred personal property classification. For example, kitchen fixtures are supported by all three criteria: (1) Movability, (2) Accessory and (3) Function.
You can use excel or any spreadsheet to assist you. But just make sure that the information is accurate and complete. The best spreadsheet is not worth anything if it is not compliant.
Cost Segregation Template
Instructions: In the following template there are instructions and areas to be completed. If something is not applicable, remove the section. Make sure that you also delete the instructions and comments that are shown in ( ).
Start with the basis for the property. Determine the land value first.
Then from the remainder, determine the value of personal property such as appliances, cabinets, HVAC and the like. Take into account wear and tear. A brand new appliance is worth more than a broken down one. If it is something that can be removed from the property in one piece, it is probably personal property. Make a list of all items with the assigned value. That doesn’t need to be included in the study, but should be available if it is ever requested. It also includes the cost of wiring and plumbing, as explained below.
Next determine the land improvement value. Some things will be worth more than the original cost, like landscaping with full-grown trees, and some things will be worth less, such as deteriorating paving on the driveway.
You are now left with the depreciable value for the structure itself.
Cost Segregation for (property):
Expertise And Experience
(Name) has the following experience with real estate:
(Name) has retained the accounting firm of Diane Kennedy, CPA as a resource for applicable tax law in this area.
As such, (he/she) is qualified to perform a cost segregation study for the stated property.
Detailed Description of the Methodology
This study used a Detailed Engineering Cost Estimate Approach to complete the cost segregation study. This approach utilizes a site inspection. The improvement assets are identified, quantified and documented using accepted cost estimates.
Appropriate unit price factors and/or multipliers were utilized to refine the unit pricing including location, fees, deflation and wear and tear depreciation.
(Name) prepared the worksheets, established quantities and completed the costing. A CPA experienced in cost segregation studies reviewed each asset and classified them as real property (27.5 years), land improvements (15 years) or personal property (5 years) and assigned the proper depreciable life for federal tax purposes. The asset class and associated lives for all personal property and land improvements are in accordance with Revenue Procedure 87-56, the current controlling Internal Revenue Service Pronouncement.
(Property) is a (single family home, duplex, etc). There are (insert amount) square feet located on a (insert amount) (square foot/acre) lot in (city, state).
Site improvements include:
(List items such as paved driveway, pool, concrete walkways, landscaping)
The property was initially placed in service on (date).
The total value is the tax basis in the property: (amount)
Summary of value:
- Land Non-depreciable (Amount)
- Structural & Mechanical 27.5 years (Amount)
- Site Improvements 5 years (Amount)
- Special Mechanical 5 years (Amount)
- Special Electric 5 years (Amount)
- Personal Property 5 years (Amount)
The following cost segregation template can be used for personal property: