Wouldn’t it be nice if you could immediately receive a huge cash-flow influx for your hotel, or any other commercial property you own, for that matter, such as a restaurant, apartment building, or even multi-tenant property? If you own any commercial property in the United States with a value of $300,000 or more, which these days covers about 99.9% of the market, you are odds-on to be able to take advantage of a program that the Big 4 Accounting firms have been offering their clients the past few years…without having to hire a high-priced accountant. Most property owners would qualify for this program, in that it is available to anyone who acquired commercial property from the present date all the way back to the Year 1986. In other words, if you bought an existing property, built (or are building) a new property, and have paid income taxes this past tax year, you are eligible. The only caveat is that if you acquired property via an Exchange (i.e. Starker, etc.), or plan on selling your property within the next 5 years, this program would most likely not work for you.
The program has a fancy name; but, is probably the simplest and easiest to understand, once it is explained to you. The fancy name is “Engineering Cost Segregation Study”. Here is all you need to know. When you have an Engineering Cost Segregation Study performed, it automatically allows you to depreciate your commercial property from the standard method of accounting, which is 39 years. Let’s face it, if you are a 60 year old property owner, how much depreciation on the property you currently own to you expect to enjoy when you are in your 90’s? If you think about this cynically, the Government is betting that the life of the property in terms of depreciation (39 years) is going to “outlive” most property owners! So, wouldn’t it be nice to dramatically accelerate your depreciation now, so that you can get an immediate cash-flow to you in the current tax year? Well, now you can do this legally. Here is what you need to know.
The actual basis for accepting this new accelerated depreciation method of accounting has a myriad of legal foundation dating all the way back to 1997. The important thing to know is that in order for anybody to take advantage of this program, the must hire an independent 3rd party firm to perform the Engineering Cost Segregation Study, according to the IRS Chief Counsel. However, the acceptance of the practice of Engineering Cost Segregation Studies did not come into vogue until two Rutgers Professors wrote an article that was published in the Journal Of Accountancy in August 2004. Here is the web link to that article: http://www.aicpa.org/pubs/jofa/aug2004/soled.htm
You really do not need to have a technical background here. Think about this.
If you elect to have an Engineering Cost Segregation Study performed on your commercial building (hotel or otherwise), it allows for the redefinition of certain components of your building assets to be accelerated from the standard 39 year depreciation schedule into possible segments of 5,7, 15, and 27.5 year increments. Some elements of your structure will remain at 39 years. So, for example, if you paid $250,000 in income taxes in the current tax year, and had an Engineering Cost Segregation Study done that yielded an accelerated depreciation of $125,000, you would receive a check from the Government of $125,000, once your Accountant completes and files the appropriate form, which in of itself is a straightforward process. And, the IRS requires no filing fee for this. And, in cases where the amount of the identified accelerated depreciation exceeds the amount of paid in tax from the current tax year, the commercial property owner is even able to go back the two previous years in recouping monies that have already been paid to the Government. If needed, this program even allows for a carry-forward of the accelerated depreciation garnered. So, what are the Engineers actually doing?
The role of an Engineer in performing an Engineering Cost Segregation Study encompasses the following areas: 1) Classify each of the structural components to a commercial building, 2) Identify whether the structural components are either permanent in nature, or are decorative, 3) Determine whether each structural component is incidental to the operation and maintenance of the building, 4) Apply, per IRS Regulation 1.48-1(e)(2), the sole justification test for personal property, and 6) Review applicable Legislative analysis and committee reports (i.e. Senate). Add the areas above to the responsibility of having the skill-set to have comprehended and have knowledge of all the IRS and Court rulings on Engineering Cost Segregation Studies from 1997 to the present, and you can see why finding an Engineer with the core comprehension to perform such a study is so valuable. Think about it. Accountants are not Engineers. And, the vast majority of Engineers would have no idea how to go about performing such a study. Furthermore, finding an Engineer who would charge a reasonable one time fee to perform the study that any commercial property owner could afford becomes a daunting task. I would be happy to recommend an Engineering firm that has successfully performed their service for hotels. Any reader and/or their accountant may contact me via email at firstname.lastname@example.org. In fact, with just a couple pieces of information, a free benchmark study can be provided to any commercial property owner with just the following information: 1) What year to you build or acquire the commercial property, and what was the estimated cash value of the property when it was acquired, and 2) What is the current estimated cash value of the property at the present time. Those property owners who have had improvements to the property should include a depreciation schedule.
Below is an example of the free benchmark study for a Hotel:
COST SEGREGATION STUDY REVIEW
We are pleased to provide this review for a Cost Segregation Study for Hotel Example. The following chart outlines the “benchmark” estimate for the expected results. We look forward to visiting with you to review these favorable economic results.
These results represent a benchmark of the expected results. Here is how to read this Engineering Cost Segregation Study estimate. The estimate is always conservative, unless the Engineering company has been provided with a depreciation schedule that might yield further information such as the improvements made to the property, etc. In this example, the second column from the right indicates that the property was acquired mid-year in 2005. In the tax year of 2006, assuming that the property was in the 40% tax bracket, they would have been entitled to depreciate $37,410. Now, using the Alternative Method of Depreciation, on the same property, they can depreciate $118,011. This is a difference of $80,601, which taxed at 40%, would still yield a tax savings benefit of $32,240.
Then, in the right hand column, you can see that the ongoing acceleration in the depreciation on the same property by the tax year 2009 results in an accumulated tax reduction benefit of an additional $77,327. The estimated financial impact to Hotels on a historical basis of redefining % of asset cost has shown 20-30% can be depreciated at 5 years, 3-7% at 7 years, and 2-7% at 15 years.
Once a commercial property owner has identified an Engineering firm that they are comfortable with, typically, they would complete an “Engagement Letter”. No internal staff is needed to perform the study which is done in an unobtrusive manner off-site. The Engineer will request some initial documents such as architectural plans, blueprints, depreciation schedule, etc. And, the Engineer will have a site inspection done at the premises at a time and date convenient to the owner of the building, which is included in the cost of the study.
Like any similar type of project, half of the one time Engineering fee would be due at the time the Engineering firm is retained to do the study. The balance would be paid at the time the study is delivered. The cost of the Engineering Cost Segregation Study itself is tax deductible. The Engineering firm reviews the results with the property owner, their CPA, and any member of their management team whose areas of responsibilities would include the results of the study.
The Engineering Cost Segregation Study is a legally allowable method. The key is to find an Engineering firm that specializes in these studies, and has staff members who also are fluent as construction experts and commercial property real estate. Simply having a CPA do one of these studies will not maximize savings, as the Engineers that specialize in this field know what is “in the walls”, and know the parameters of IRS approved industry standards and systems. The Engineering analysis needs to analyze construction drawings, standard cost systems, and construction analysis. An IRS memorandum even suggests a “engineering cost segregation study” as the proper application.
The Engineering Cost Segregation Study typically takes 4-6 weeks. It can reduce your year end taxes, or reduce your current quarterly estimated tax payments now. Again, the Engineering Cost Segregation Study is available not only to hotels; but, to any commercial building, including Apartment Buildings, and/or multi-tenant landlord structures (i.e. duplex, etc.). The program does not displace an Accountant; but, rather provides Accountants with a great way that they can endear themselves to their clients by suggesting this acceptable accounting practice that can maximize the tax benefits to their clients.