Although there are many applications for cost segregation, new construction projects are often first to be considered. It’s always good to have a cost segregation study performed as soon as a property is placed in service. This allows the taxpayer to take full advantage of accelerated depreciation deductions from day one.
Normally, the request to perform the cost segregation study comes after construction is completed and the building is placed in service. While substantial benefits are generated by performing a study at this stage, even greater benefits can be achieved if the cost segregation provider is involved directly from the design phase. Unfortunately, many owners and tax advisors are unaware of this valuable opportunity and many cost segregation consultants are unfamiliar with, or lack the engineering and construction expertise, to utilize this application.
Getting your cost segregation consultant involved during the design phase can be very beneficial, especially on larger or more specialized projects. Early involvement allows the cost seg provider the opportunity to understand the project and make valuable suggestions before it’s too late. While some issue can be addressed during construction, it is better to know ahead of time to avoid unnecessary change orders. Ideally, you’ll want to make this introduction after the conceptual drawings are finished, but before the project goes out to bid. This will also provide an opportunity to request bids in a format that is more conducive to performing the study.
The recommendations made during design will mostly deal with the types of materials being used and manner of affixation. Both are important things to consider from a tax perspective. Small changes to design or types of materials can generate large tax benefits.
A classic example is whether to use paint or some form of removable wall covering. Paint is depreciated using a 39-year recovery period, while removable wall coverings can be depreciated over five or seven years. Additional design elements to consider include wall partitions, floor coverings, lighting, and canopies, among others.
The design phase also provides an opportunity to check how drawings are labeled. The intended use of an asset is a key consideration in determining whether it will qualify for a shorter recovery period. Detailed labeling can help provide a more defensible position with regard to intended use. Lighting is a great example of this. Labeling the panel schedule of the blueprints to separately identify base building and accent lighting provides a clear distinction. Base building lighting is a 39-year item in the eyes of the IRS, but accent lighting can be depreciated over five or seven years. This is especially important in properties that have a high percentage of special use assets, such as medical facilities, auto dealerships, restaurants, and manufacturing facilities, to name a few.
From a cost segregation standpoint, there are two important elements of the construction phase. First is the ability to make last minute suggestions pertaining to materials and installation. Change orders may affect the initial design and will need to be reviewed. Second is the documentation process. Building a defensible position for the classification of assets is the cornerstone of a good cost segregation study. Solid photographic and/or video documentation is a key part of this process. Involvement during construction gives the cost segregation provider the ability to document aspects of the property that will not be visible once construction is complete.
The Bottom Line
Getting a cost segregation provider involved early can provide real value, but it can also create some challenges. It is important that the cost segregation provider is familiar with the entire design and construction process so they don’t get in the way. The last thing the design and construction teams want is someone slowing down their progress.
Although it’s tempting, don’t assume that the architect or contractor can properly allocate costs or prepare a defensible cost segregation study. Most architects and general contractors don’t have knowledge of the tax regulations and won’t be willing to defend the taxpayer in the event of an audit. Go ahead and spend the extra time finding a reputable cost segregation consultant who is able to identify opportunities and provide recommendations to ensure you achieve the most favorable tax treatment.