““Understanding Understanding Cost Segregation Studies”Cost Segregation Studies”

Presented by:

Cathy A. Harris, CPA

Director, Cost Segregation Group

What is a Cost Segregation What is a Cost Segregation Study?Study?

A cost segregation study (CSS) is a A cost segregation study (CSS) is a systematic engineering-based analysis and systematic engineering-based analysis and classification of all capital expenditures classification of all capital expenditures associated with a newly constructed, associated with a newly constructed, renovated, recently purchased or existing renovated, recently purchased or existing property. property.

CSS GoalCSS Goal

The goal of a CSS is to identify assets as The goal of a CSS is to identify assets as either real or personal property and to either real or personal property and to separate the capital expenditures into the separate the capital expenditures into the most optimum MACRS asset classifications most optimum MACRS asset classifications allowed by IRS code, revenue rulings and allowed by IRS code, revenue rulings and existing case law.existing case law.

Why is a Cost Segregation Why is a Cost Segregation Study a Good Idea?Study a Good Idea? A properly completed Cost Segregation A properly completed Cost Segregation

Study will:Study will: Maximize tax deferrals through Maximize tax deferrals through

accelerated depreciationaccelerated depreciation Increase cash flow through a decrease in Increase cash flow through a decrease in

tax exposure – potential for a big “catch-tax exposure – potential for a big “catch-up”up”

Minimize taxable gains on the sale of Minimize taxable gains on the sale of propertyproperty

What Type of Owners What Type of Owners Benefit?Benefit?

Taxpayers with a commercial property having Taxpayers with a commercial property having depreciable basis of $750,000 or greater.depreciable basis of $750,000 or greater.

Taxpayers who have constructed, purchased, Taxpayers who have constructed, purchased, expanded or renovated commercial properties expanded or renovated commercial properties since 1987.since 1987.

Lessees and lessors who have made leasehold Lessees and lessors who have made leasehold improvements of $750,000 or greater.improvements of $750,000 or greater.

Owners of properties about to be sold or who Owners of properties about to be sold or who have sold property in recent years.have sold property in recent years.

Primary Property Primary Property Recovery PeriodsRecovery Periods

ComponentComponent

BuildingBuilding Land ImprovementsLand Improvements Furn, Fixt. & Equip.Furn, Fixt. & Equip. FF&E, Retail & ServiceFF&E, Retail & Service Information SystemsInformation Systems

Recovery PeriodRecovery Period

27.5 or 39 years27.5 or 39 years 15 years15 years 7 years7 years 5 years5 years 5 years5 years

Average Value Misclassified Average Value Misclassified by Property Typeby Property Type

ManufacturingManufacturing HotelsHotels ApartmentsApartments RestaurantsRestaurants Office BuildingsOffice Buildings Research & DevelopmentResearch & Development HospitalsHospitals Tenant ImprovementsTenant Improvements Retail Retail Grocery StoresGrocery Stores

20% - 60%20% - 60% 15% - 40%15% - 40% 20% - 50%20% - 50% 10% - 40%10% - 40% 10% - 40%10% - 40% 20% - 50%20% - 50% 20% - 50%20% - 50% 15% - 50%15% - 50% 15% - 40%15% - 40% 15% - 50%15% - 50%

Examples of Reallocated Examples of Reallocated Personal PropertyPersonal Property

CarpetingCarpeting WallcoveringsWallcoverings CabinetryCabinetry Specialty lightingSpecialty lighting Specialty electric and plumbingSpecialty electric and plumbing Built-in shelvingBuilt-in shelving Loading dock equipmentLoading dock equipment

Examples of Reallocated Examples of Reallocated Land ImprovementsLand Improvements

AsphaltAsphalt ConcreteConcrete Parking lot lightingParking lot lighting Curb and guttersCurb and gutters SignageSignage LandscapingLandscaping

Benefits of a Cost Benefits of a Cost Segregation StudySegregation Study

The present value of income tax savings, The present value of income tax savings, at 7% interest rate, for each $100,000 in at 7% interest rate, for each $100,000 in property identified as personal property property identified as personal property versus nonresidential real property with a versus nonresidential real property with a 39 year life:39 year life:

5 Year property - $17,2005 Year property - $17,200 7 Year property - $15,8007 Year property - $15,800 15 Year property - $9,600 15 Year property - $9,600

* * Assumes 35% Federal Income Tax RateAssumes 35% Federal Income Tax Rate

Average NPV SavingsAverage NPV Savings

Building TypeBuilding Type

Ave. First Year Ave. First Year Savings/ Savings/

$1million of $1million of Depreciable Depreciable

PropertyProperty

Avg. NPV Savings / Avg. NPV Savings / $1million$1million

Of Depreciable Of Depreciable PropertyProperty

ApartmentsApartments $ $ 10,00010,000 $ $ 36,000 36,000

HotelsHotels $ $ 20,00020,000 $ $ 64,000 64,000

Office BuildingsOffice Buildings $ $ 8,0008,000 $ $ 39,000 39,000

Office ParksOffice Parks $ $ 7,5007,500 $ $ 35,000 35,000

High-rise Office BuildingsHigh-rise Office Buildings $ $ 6,0006,000 $ $ 24,000 24,000

Shopping CentersShopping Centers $ $ 10,00010,000 $ $ 44,000 44,000

Flex BuildingsFlex Buildings $ $ 9,0009,000 $ $ 39,000 39,000

Office-WarehousesOffice-Warehouses $ $ 7,0007,000 $ $ 34,000 34,000

ManufacturingManufacturing $ $ 7,5007,500 $ $ 34,000 34,000

Auto DealershipsAuto Dealerships $ $ 11,00011,000 $ $ 51,000 51,000

Catch-Up DepreciationCatch-Up Depreciation

For existing properties that are not For existing properties that are not optimally classified, the IRS provides an optimally classified, the IRS provides an automatic consent procedure to make automatic consent procedure to make changes on a “catch-up” basis.changes on a “catch-up” basis.

Depreciation differences between current Depreciation differences between current and optimum property classifications are and optimum property classifications are currently allowed to be fully expensed in currently allowed to be fully expensed in the year of change.the year of change.

Year of Sale StudyYear of Sale Study

Catch-up depreciation taken at ordinary Catch-up depreciation taken at ordinary tax rates (up to 35% federal rate).tax rates (up to 35% federal rate).

Additional gain on sale recognized at Additional gain on sale recognized at capital gain rates (15% federal rate).capital gain rates (15% federal rate).

Up to 20% tax savings on additional Up to 20% tax savings on additional depreciation taken in the year of sale.depreciation taken in the year of sale.

Recent Developments Relating Recent Developments Relating to Depreciable Propertyto Depreciable Property

Bonus Depreciation is back for 2008 and Bonus Depreciation is back for 2008 and 2009!!!2009!!! For assets contracted and placed in service For assets contracted and placed in service

between January 1, 2008 and December 31, between January 1, 2008 and December 31,

2009.2009. Enhanced Small Business ExpensingEnhanced Small Business Expensing

Deduct capital expenditures up to $250,000 Deduct capital expenditures up to $250,000 phased out after $800,000 in additions.phased out after $800,000 in additions.

Increase extended from 2008 through 2009.Increase extended from 2008 through 2009.

Recent Developments Relating Recent Developments Relating to Depreciable Propertyto Depreciable Property 5 year NOL carryback for small businesses.5 year NOL carryback for small businesses. Expenditures related to tangible property: Expenditures related to tangible property:

Current deduction v. capital expenditure.Current deduction v. capital expenditure. Improvements to restore property to former Improvements to restore property to former

working condition or to keep property in working condition or to keep property in ordinary efficient operating condition may be ordinary efficient operating condition may be currently expensed.currently expensed.

Improvements which add to the value or Improvements which add to the value or prolong the useful life of the property must be prolong the useful life of the property must be capitalized.capitalized.

IRS Cost SegregationIRS Cost SegregationAudit Technique GuideAudit Technique Guide

• This guide was developed to assist IRS agents in This guide was developed to assist IRS agents in the examination of cost segregation studies. the examination of cost segregation studies. Latest update was December 2007.Latest update was December 2007.

• It identifies cost segregation methodologies that It identifies cost segregation methodologies that the IRS believes are valid and those which the IRS believes are valid and those which require additional scrutiny.require additional scrutiny.

• The guide identifies the attributes of what the The guide identifies the attributes of what the Service believes is a quality cost segregation Service believes is a quality cost segregation study and report.study and report.

The ProcessThe Process

• Based on preliminary information given, we use Based on preliminary information given, we use our extensive database and estimate the our extensive database and estimate the expected tax benefit.expected tax benefit.

• A fixed fee proposal is offered.A fixed fee proposal is offered.

• A site visit is made, and the data is processed.A site visit is made, and the data is processed.

• Client is under no obligation to pay unless they Client is under no obligation to pay unless they receive a net benefit from the study.receive a net benefit from the study.

• Average turn around is 30 to 60 days.Average turn around is 30 to 60 days.

Steps in a Cost Segregation StudySteps in a Cost Segregation Study Perform on-site property tour to collect data.Perform on-site property tour to collect data. Process detailed information from property tour, Process detailed information from property tour,

site map, blueprints and specifications.site map, blueprints and specifications. Prepare itemized list of all property Prepare itemized list of all property

components.components. Compute actual or estimated acquisition and Compute actual or estimated acquisition and

installation costs for each identified component.installation costs for each identified component. Allocate indirect costs to appropriate property Allocate indirect costs to appropriate property

components.components. Research applicable IRS code, regulations and Research applicable IRS code, regulations and

case law.case law. Determine appropriate depreciable life for each Determine appropriate depreciable life for each

property component.property component. Prepare and present final report.Prepare and present final report.

DeliverableDeliverable Cost Segregation ReportCost Segregation Report

Preparer InformationPreparer Information Project Background Information.Project Background Information. Cost Segregation Methodology.Cost Segregation Methodology. Asset Classification Summary.Asset Classification Summary. Federal Tax Classifications.Federal Tax Classifications. Federal Tax Classifications Support.Federal Tax Classifications Support. Project Related Fees and Service.Project Related Fees and Service. Exhibit 1 - Federal Income Tax - MACRS listing Exhibit 1 - Federal Income Tax - MACRS listing

of assets and associated class lives. of assets and associated class lives. Exhibit 2 – Photographs.Exhibit 2 – Photographs.

Shopping Center ExampleShopping Center Example Purchase Price Purchase Price

$3,700,000$3,700,000 NPV Tax Savings NPV Tax Savings

$193,000$193,000

Allocation

Building 67%

LandImprovements15%PersonalProperty 18%

Hotel ExampleHotel Example Purchase Price Purchase Price

$3,300,000$3,300,000 NPV Tax Savings NPV Tax Savings

$178,000$178,000

Allocation

Building 68%

LandImprovements7%PersonalProperty 25%

Apartments ExampleApartments Example

Purchase Price Purchase Price $22,000,000$22,000,000

NPV Tax Savings $969,000NPV Tax Savings $969,000Allocation

Building 55 %

LandImprovements27%PersonalProperty 18%

Example Catch-up StudyExample Catch-up Study

Shopping Center capitalized building at Shopping Center capitalized building at $1,517,000 between 1990 and 2005.$1,517,000 between 1990 and 2005.

Reclassified $300,000 to 5 year assets.Reclassified $300,000 to 5 year assets. Reclassified $249,000 to 15 year assets.Reclassified $249,000 to 15 year assets. Catch-up Section 481 Adjustment through Catch-up Section 481 Adjustment through

2005 was $281,000. Adjusted on the 2006 2005 was $281,000. Adjusted on the 2006 tax return.tax return.

Savings in 2006 to owners exceeding Savings in 2006 to owners exceeding $100,000.$100,000.

Year of Sale Benefit Year of Sale Benefit ExampleExample

Purchase Price: $11,400,000Purchase Price: $11,400,000 Sales Price: $25,000,000Sales Price: $25,000,000 Year of Sale Tax w/o CSS: $2,600,000Year of Sale Tax w/o CSS: $2,600,000 Year of Sale Tax w/ CSS: $2,300,000Year of Sale Tax w/ CSS: $2,300,000 Tax Savings exceeding: $330,000Tax Savings exceeding: $330,000

Benefit Over Price Benefit Over Price (Return on Investment)(Return on Investment)

Property TypeProperty Type ROIROI

ApartmentApartment 4000%4000%

Auto DealershipAuto Dealership 3500%3500%

HotelHotel 1800%1800%

ManufacturingManufacturing 2000%2000%

Office BuildingOffice Building 3750%3750%

Office ParkOffice Park 5000%5000%

Retail StoreRetail Store 2000%2000%

Shopping CenterShopping Center 2500%2500%

Office-WarehouseOffice-Warehouse 1750%1750%

Flex BuildingFlex Building 1250%1250%

High Rise BuildingHigh Rise Building 6000%6000%

Storage FacilityStorage Facility 1250%1250%

Why use The Cost Segregation Why use The Cost Segregation Group?Group? Experience providing studies since 1998.Experience providing studies since 1998. Billions of dollars in real estate Billions of dollars in real estate

segregated.segregated. Engineers and CPAs perform studies.Engineers and CPAs perform studies. Senior member of the ASCSP on staff.Senior member of the ASCSP on staff. 100% IRS audit success.100% IRS audit success. Authors of Authors of CCH’s Practical Guide to Cost CCH’s Practical Guide to Cost

SegregationSegregation..

Contact UsContact Us

Visit our website: Visit our website: www.costsegregationgroup.comwww.costsegregationgroup.com

The Cost Segregation GroupThe Cost Segregation Group

Cathy Harris, DirectorCathy Harris, Director

charris@costsegregationgroup.comcharris@costsegregationgroup.com

(757) 533-4118(757) 533-4118