Cost Segregation Strategies Could Save Manufacturers Thousands On Taxes

Recent changes in the tax laws could mean that you might see reasons for substantial tax deductions. The key to those deductions is something called a cost segregation study.

If you’re like most manufacturers, when you look around your plant and property, you see a lot of land and trees and improvements you’ve made to your lot and building. But recent changes in the tax laws could mean that you might also see reasons for substantial tax deductions. The key to those deductions is something called a cost segregation study.

“The objective of this study is to identify the components of the manufacturer’s building and property that qualify as personal property or land improvements and to depreciate them according to some new changes in the tax laws,” says John Toscano, CPA, a partner and director of the Manufacturing Industry Group at Filomeno & Company, P.C. “When these items are properly identified, they can generate immediate tax savings by accelerating depreciation deductions and deferring taxes.”

In the past, the IRS didn’t have favorable depreciation of these individual elements. They were treated as if the building and all its contents had a business “life” of 39 years. So, manufacturers would spend millions on their buildings and improvements and deduct only 1/39 per year. Recent changes in the tax code have altered this. The key to this approach is to identify certain components of the building that qualify as personal property or land improvements and depreciate them separately. Things like shrubs, sidewalks and even built-in bookcases, office walls and suspended ceiling tiles can be treated as having shorter lives for tax purposes. The identification of these components comes from a cost segregation study. An accountant, who works with an engineer to identify the components of the building that would qualify for shorter lives, performs the study. For example, you can depreciate lighting and plumbing fixtures and carpeting over a seven-year period. Landscaping and shrubbery has a 10-year depreciation period and the parking lot can be depreciated over 15 years. And, while this works most effectively for a new building, you can get retroactive deductions for older buildings. This tax treatment is relatively new.

“These favorable adjustments to a single tax year went into effect for tax years ending on or after December 31, 2001,” points out Mr. Toscano. “In the past, such IRS Section 481 (a) adjustments had to be spread over four years, thus reducing the immediate impact of the benefit. Now, they can be taken in a single year. If you’re used to the old 4-year deduction period, you’re in for a pleasant surprise because, with these changes, you can take the difference between the deprecation you took in the past and the depreciation you’re allowed under this cost segregation study. You could be looking at tax savings of thousands of dollars depending upon the building’s size, the makeup of the plant’s components and how long you’ve owned it. For one of our clients, it meant a $200,000 tax deduction.”

You’ll need three elements for this analysis: depreciation schedules, drawings or plans of existing building(s) and the results of any on-site inspection. Once you have these, contact your accountant. He or she will partner with an engineering firm to do the Cost Segregation Study. They will send an engineer to do a walk-through of the property, looking for the various elements and identifying their depreciable lives. After the walk-through, they will give you their best estimate as to whether or not the cost segregation study would be of benefit. If the answer is yes, the engineer will then do a thorough analysis of the property and plant. This could be a 4- to 5-week project. The study itself could cost between $10,000 and $30,000 for buildings up to $5 million. “If that sounds like a lot of money, I can tell you that when done right, it can be worth it,” says Mr. Toscano. “Our firm’s been doing these studies for the past 9 months in partnership with an engineering firm. The tax savings have been dramatic. For example, we did a study on a building that was purchased in 1983 for about $750,000. The 1-year adjustment was more than $70,000. For a larger building, we had a 1-year adjustment of $200,000 on a $2,500,000 building.”

Mr. Toscano summarizes the benefits of the cost segregation study this way: “If you own the real estate on which your plant sits and you rent it back to the dealership, you may be able to take a substantial deduction in one year, especially if you are showing taxable income from renting the property to the company. I think it’s worth looking at this approach. In our experience, it’s been worth it. The biggest drawback is the time it takes, so if you’re considering it for this year, I urge you to start immediately.”

For more information contact Filomeno & Company, P.C. Its Web site is www.filomeno.com. For questions about the pros and cons of the cost segmentation study, contact Mr. Toscano at jt@filomeno.com.