The accounting industry has embarked on a transition towards adding cost segregation to advisory services. Technological advancement has simplified compliance tasks and has thus created more time for CPA firms to offer these value-added services to clients. However, oftentimes when you are looking for opportunities to proactively help your clients, it can be difficult to find solutions that you are well-versed in, are exciting, or will be great for your firm’s margin. It can also be intimidating to dive into new services you may not know about, even if the service can provide ample amounts of value to your clients—so what do you do?
In this episode of Pulse of Practice “Outsourcing for Knowledge”, we look into expanding intellectual capital for your firm or outsourcing to other businesses who already have the skills and ability to help your clients best. One great example of outsourcing is through cost segregation. Cost segregation is a concept that most firms and accountants are familiar with, but only in concept. It’s important that your firm prepares to tackle resources like cost segregation so your client has all their options open, and your firm can maximize the value provided to clients.
What is cost segregation?
Cost segregation is a strategic tax planning tool that helps individuals and organizations who have purchased, remodeled, or constructed any type of real estate. A cost segregation study reclassifies specific parts of a client’s owned or leased property for depreciation purposes. So how does it work?
On average, 20% to 40% of a building structure’s interior and exterior components belong to tax categories that can be written off faster than the building itself. The cost segregation study’s goal is to identify these parts and depreciate them over a shorter time frame, like 5-15 years, rather than the property which can sometimes take over 30 years to depreciate. Segregating these components for your client will increase their cash flow by speeding up depreciation deductions as well as deferring federal and state income taxes. Cost segregation can be applied to nearly all kinds of real estate, ranging from warehouses to apartment buildings, hospitals to restaurants, and retail stores to banks.
A good cost segregation study will evaluate information from various sources regarding a piece of real estate like inspections, records, blueprints, physical inspections, etc. This allows for an estimate of component values and can be completed at any time after the construction, purchase, or remodel of the property (although the sooner is better!).
This practice has been around since 1977 but was limited to larger players in the industry due to the manual work it involved. However, this has changed in recent times, especially after the arrival of the Tax Cuts and Job Act. Many clients believe they need at least a million-dollar building to realize value from cost segregation—this is not true! Buildings as low as $200,000 can still get a great tax benefit for the cost of this study. In fact, the rule of thumb is for every $500,000 of building, the tax benefits the client sees can be between $20,000 to $80,000.
What other value can I create with a study on adding cost segregation to advisory services?
Along with the benefit of increasing cash flow for your client, increasing depreciation earlier, and deferring federal and state income taxes, there are many other value-adding benefits that arise from a cost segregation study. For example, a cost segregation study:
- Permits future write-offs if certain structural components are replaced
- Can allow taxpayers to earn up to 50% depreciation deduction on certain qualifying assets
- Avoids filing amended tax returns; if building is owned for more than a year, CPAs can provide a 31-15 form that will inform the IRS, creating a very simple process where the IRS is provided with calculated defendable numbers to apply from the client’s standpoint
- Creates losses to carry-back, or forward when needed
- Is relatively inexpensive to conduct the cost segregation study when compared to the value it provides clients
To avoid risks when conducting a cost segregation study for your client, ensure you are employing professionals who have strong engineering, construction, architecture, and tax/accounting backgrounds. If the third-party firm you are hiring to conduct the study lacks this deeper understanding, they may not be able to maximize the savings they identify for your clients.
Cost segregation in practice
One great example of cost segregation savings is from a multi-billion dollar bakery in Massachusetts. The bakery purchased a new manufacturing facility to fit its expansion and future needs, and with cost segregation they were able to segregate costs into 7-year, 15-year, and 39-year categories. By segregating components of the real estate into these sections, the bakery accelerated depreciation; around 6% of the facility categorized as 15-year improvements, and 65% of the facility categorized as 7-year improvements. The result? This bakery realized $930,000 in savings with their cost segregation study.
Be prepared to provide services that will satisfy your clients best
Many clients know very little about cost segregation. However, as the practice is becoming easier and easier to execute, it is discussed more within the tax and accounting space. Oftentimes, CPAs who have not told their client about cost segregation may face questions like, “Why didn’t I hear about this before?”. No one wants to hear that from a client. No one wants to be the firm that is falling behind or failing to provide value to their clients.
Before you get asked a question like this about, make sure you are well-equipped to provide your clients with the option to conduct a cost segregation study. Be prepared to help your client explore cost segregation and the choices that will follow it, such as where to direct the money they save. With an advisory mindset, provide honest and thoughtful guidance that can allow your client to make a decision that suits their needs best.
Yet, once you can show this value, clients tend to not worry about the past. Rather, they will think forward about the possibilities that await them after using services like cost segregation. So, for CPAs who may be nervous to do something different and engage with cost segregation, remember this! Get to the point of showing value and direct the customer to look forward, because they will.
