Savvy hotel owners may end up paying Uncle Sam a lot less on their 2008 taxes if they explore cost segregation. They can start by requesting a no-charge preliminary analysis from a competent cost segregation firm. This report will show them and their tax preparers an estimate of the after-tax dollars hidden in their properties as well as the cost of commissioning the actual cost segregation study.
Under provisions in the 2009 American Recovery and Reinvestment Act, property owners who decide to commission a paid engineering-based cost segregation study (based on that free preliminary analysis), could possibly receive a refund on taxes paid over the last 5 years. The popular myth is that only big multinational firms can afford these studies, but really it’s available, and cost effective, for the little guy too. Therefore, if an owner has purchased, built or renovated a property within the last 15 years, the following article outlines the possible eligibility for significant tax savings.
What is Cost Segregation?
In typical accounting practice, 100 percent of a building’s costs are depreciated on a straight line basis over 39 years. Yet, according to the IRS, many components of a building — and all land improvements — have shorter depreciation lives. Cost segregation allows property owners to reduce their current tax bills legally by identifying and depreciating those assets more rapidly.
Sometimes as much as 40 percent of a building’s purchase price, which could be cost segregated, is incorrectly buried in the “building” line of a hotel’s Depreciation Schedule and is being depreciated on a straight-line basis over 39 years.
To parse out these individual depreciations, hoteliers can hire a cost segregation firm. These firms conduct an onsite review and then take the total purchase price (minus the land cost) or the total construction cost (including soft costs) and separate (“segregate”) individual building components, and their associated costs, into their correct, shorter depreciation lives of 5, 7 or 15 years.
Can An Accountant Do This?
The IRS Cost Segregation Audit Techniques Guide provides that this kind of study be performed by “qualified” individuals or firms, such as those employing “…personnel competent in design, construction, auditing, and estimating procedures relating to building construction.” Cost segregation firms have expertise in the relevant IRS regulations, rulings and court cases to insure that they are maximizing the benefit to their client while staying within all IRS guidelines. While accountants probably cannot do the cost segregation study, they will be the people to apply the results of the study to the tax return. Cost segregation is a tool for these accountants.
What Can An Accountant Do With a Cost Segregation Study?
Not only can tax professionals help hoteliers recover $60,000 to $80,000 in after-tax benefits for each $1 million that is depreciated, but also they can use “double declining balance” depreciation for the 5- and 7-year costs segregated, and use “150 percent declining balance” depreciation for the 15-year costs segregated. The retroactive clause for these refunds allows accountants for properties that have been owned for a while to “catch up” on all of the missed depreciation expenses identified in the cost segregation study from those closed tax years without amending those tax returns.
Furthermore, if the appraisal for a purchased property indicates that major structural components (roof, windows, boiler, etc.) will be replaced sooner than their 39-year depreciation lives, hoteliers need to ensure that their costs are itemized in a cost segregation study. When those components are replaced, the undepreciated balance can be written off. For example, the costs of the swimming pool, landscaping and parking lots will be itemized as 15-year property in a cost segregation study. They generally do not burn, so why include them in a fire insurance policy?
How Will This Affect 2008 Taxes?
The 2009 stimulus package temporarily broadens the “net-operating loss (NOL) carryback” to 5 years. Tax preparers may now apply the “NOL” created by the cost segregation study to past tax bills and get a refund on taxes paid as far back as 2003.
If the actual cost segregation study will not be completed in time to become part of an April 15th filing, a preliminary analysis that shows the expected results of the paid study can reduce the amount of the tax payment necessary if an extension is filed. If property owners have already filed their 2008 taxes, their tax preparers can use the cost segregation study as the basis for minimizing their future estimated quarterly tax payments.
The first step is to request a no-charge preliminary analysis. This usually can be done with one phone call and the results should arrive in a few days. When an accountant sees the tax benefits and the cost of the paid study, and applies them to each tax situation, it will be obvious if it makes sense for a property owner to commission the paid cost segregation study.
Questions to Ask When Selecting a Cost Segregation Firm
• Do they pass all the tests defined by the IRS? Read the Cost Segregation Audit Techniques Guide.(http://www.irs.gov/businesses/article/0,,id=134180,00.html ).
• Will they provide a free preliminary analysis specific to your property? It should estimate the tax benefits as well as quoting the cost of the paid study
• Will they insist on doing an on-site physical survey of your property?
• Do they have CPAs and tax attorneys to work with your tax preparers? When it comes time to apply the results of a cost segregation study to your tax return, you can be sure that your financial people will have questions.
• In the unlikely event of an IRS audit of the study, will your cost segregation firm attend that audit and defend their study at no additional charge to you?
Michael Donohue has over 20 years experience as a management consultant, including six years with Coopers & Lybrand. He now represents a firm whose engineers, CPAs and tax attorneys focus solely on cost segregation.