For some reason tax accountants have yielded much of their authority in the area of cost segregation to so called cost segregation experts. I think this is a mistake.
With the recent enactment of harsher tax-preparer penalty rules tax preparers are well advised to never to delegate their tax judgment to anyone who is not trained in the tax law. This would most certainly include cost segregation firms.
Here is how cost segregation works:
Let’s say Barack McCain builds a business building for an overall cost (exclusive of land costs which are not depreciable) of $1,000,000.00 and places the building in service on January 1, 2009. If the entire cost is categorized as real property McCain will be entitled to take a depreciation deduction in 2009 calculated as follows:
Tax Benefit Without Cost Segregation
$1,000,000.00/39 or $25,641. Assuming he is in the highest tax bracket, the benefit via tax savings of that depreciation deduction would 35% x $25,641 or $ 8974.00.
Tax Benefit With Cost Segregation
But if he were able to identify and segregate, say, $400,000.00 of the cost of the building into five year property, his benefit via tax savings would be as follows:
$ 400,000.00/39 or $10,256 PLUS $ 400,000.00/5 or $80,000.00. His depreciation deduction in 2009 would be $90,256. Applying the 35% tax rate to that deduction yields a benefit of $31,589.00. That’s a $ 22,615.00 increase in 2009 tax savings.
Schedules of construction costs are sent to the accountants who prepare the depreciation schedules and tax returns. If your contractor did not break out the various building components, the accountant will be hard-pressed to identify them. If this is the case, the construction costs related to the entire project are placed in a long tax life.
A proper cost segregation study performed by an experienced tax lawyer or CPA will help you identify, segregate, and reclassify these components into shorter depreciable tax lives. If done and documented properly, the tax savings are often enormous.
5 responses so far ↓
1 Joey Palin // Sep 8, 2008 at 4:24 pm
I’m trained in law. I also have substantial experience in cost segregation issues. But I wouldn’t hold myself out as working in the area because doing it and documenting it properly is cost prohibitive. When it gets kicked on audit, let me know.
2 Peter // Sep 9, 2008 at 8:47 am
Thanks for the comment, Joey.
If you have the experience and the training, why not you?
Maybe you aren’t charging enough.
3 Joey Palin // Sep 9, 2008 at 1:18 pm
It’s the opposite problem: I can’t charge as little as the non-practitioners. Also, given the volume of competition, taxpayers prefer cost segregation consultants untrained in tax law because many routine positions could not reach MLTN or substantial authority, at least not without a wink and a nod to the audit lottery. We’ve all seen the problem firsthand: a non-practitioner takes a position based on a superficial similarity to the facts in a revenue ruling or a case without realizing that the determinative facts are against him or her. (We see the same thing from IRS engineers, but they’re not practitioners either. ) A corollary problem involves non-practitioner consultants who take positions without adequately investigating the facts based on those same superficial similarities.
All of this is great for me, because, once it is contested on audit, I can go in and properly develop the facts for the disputed items, subbing out the cost segregation study if the original engineering/valuation work was deficient.
But, to return to your point on penalties, what most practitioners don’t realize is that there is a large body of case law regarding on whom taxpayers can rely for accuracy-related penalties. Given where things are headed, it is unlikely that a non-practitioner, even with Big 4 experience, will justify a practitioner’s reliance on legal tax questions or on mixed questions of fact and law.
If you, (or someone else), can deliver a cost segregation study produced under the supervision of a competent practitioner for those legal and mixed issues at a price point that works in the market, more power to you.
4 Peter // Sep 9, 2008 at 9:42 pm
Good points, all.
But I was referring to situations in which tax practioners yield to non-practioner’s cost seg studies and rely on those studies when they prepare, sign and file the return.
If you’re going to take the responsibility of signing the return, you ought to have more involvement (and a larger share of the cost seg study fees) than the non practioner who doesn’t sign the return.
5 Tax Primer for New Landlords // Apr 4, 2009 at 9:04 am
[...] and washers and dryers along with the rental of the premises. These items, to the extent that their cost
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