good ideas



From contractor to consultant
Cost segregation studies are a valuable opportunity

It's not hard to understand why some contractors might resist getting involved in cost segregation studies. The process takes time and requires painstakingly detailed record keeping. And, of course, the resulting tax benefits apply solely to the property owner.

But when you establish a reputation for being able to help complete these studies properly, you're no longer just a contractor - you're a consultant. Suddenly you're building goodwill with clients and prospects, garnering insights that can lead to more competitive bids and differentiating your business from the competition.

What's the goal?

As the name implies, cost segregation studies separate the component costs of a commercial or income-producing construction project. The goal is to reclassify certain construction-related expenses into costs that the owner can depreciate over five, seven or 15 years rather than the 27.5 years (income-producing residential) or 39 years (commercial) typically required for a building.

To qualify for a shorter depreciation period, costs must be related to fixed assets that aren't associated with the operation or maintenance of the building. Specialized electrical systems, for example, may qualify if they are specific to equipment such as computers or telephones.

Thus, if the owner can classify 50% of the total electrical costs in an apartment building as personal property, he or she may depreciate those costs over five or seven years. Otherwise, the owner would have to depreciate the entire electrical expenditure over the 27.5-year schedule for the building.

So say electrical costs total $200,000 and the owner can depreciate $100,000 over five years as personal property. The average annual write-off will be $20,000. By contrast, the same $100,000 depreciated over 27.5 years would mean an average write-off of about $3,600 per year.

Ultimately, the accelerated depreciation schedule can increase after-tax cash flow for the owner by accelerating deductions. Beware, though, that these tax deductions only matter if there is sufficient taxable income to use them and the owner's deductions are not limited by the passive activity rules.

How's it done?

Generally, the most effective way to conduct a cost segregation study of substantial size is through an engineering approach.

Here a team of analysts skilled in construction and engineering, as well as taxation and accounting, work together to identify the assets that may qualify for accelerated depreciation. The team then associates costs with each asset and develops a report documenting the findings.

To accomplish all this, the team must examine drawings and specifications; visit the site; and assemble invoices, purchase orders, change orders and a host of other documents that will satisfy the IRS should it challenge the study's findings.

Your role in the process is pivotal. As the contractor, you are, in a very real sense, the holder of the keys to the vault. All the documentation required to support reclassification based on actual costs is likely in your files. And therein lies a problem.

When is best?

Contractors don't live in the past. You devote all your energy to the projects you're working on now, and you don't have a great deal of time to spend combing archived files for cost segregation purposes.

Thus, quite understandably, you may not be particularly eager to sit down with an owner and his or her CPA to discuss whether something can be removed, relocated or detached from a building or how much maintenance a particular asset requires.

That's why, whenever feasible, you should try to encourage owners to undertake cost segregation studies as early as possible in the construction process. By doing so, you'll be able to provide required documentation as you receive it, saving yourself considerable headaches down the road.

Ideally, a cost segregation study should begin shortly after you win the bid. If you work with the CPA heading up the analysis from the get-go, you'll know exactly what the study team will need as the job progresses, making the entire process more efficient. You may even be able to suggest better ways to determine certain costs.

Worth the effort?

With so much on your plate already, participating in a cost segregation study may seem a daunting prospect. But remember, you won't be on your own - a CPA and other team members will share the load. And if you wind up adding value to your relationship with the owner and bolstering your bidding knowledge, you'll no doubt find it well worth the effort.

For more information and help making this work for you, contact Russ Panks at rpanks@kaufmanrossin.com
Cost segregation study methods may vary

Many contractors worry that participating in a cost segregation study may force them to reveal too much detail about their building processes and, thus, give away trade secrets that give them a competitive advantage. If you prefer not to provide information such as specific unit costs, you may be able to provide only a lump-sum cost - the total material and labor cost for the asset.

In cases where records relating to allocation of certain costs aren't available, the CPA involved may ask you for an estimate or use estimating guides to determine costs. These can result in adequately accurate results - particularly if they are later reconciled to actual costs.

In still other cases, the CPA will contact you via a survey to obtain cost information on a project. Because the responses received under such an approach vary, however, the actual data may not be comparable and could result in less accurate allocations.