Many commercial property owners could cut their federal income taxes by tens of thousands of dollars or more through a well-established but little-used tax application known as “cost segregation,” according to financial services industry experts.
Traditionally, commercial buildings — shopping centers, medical offices, condominiums, car dealerships, mini-storage facilities and the like — have been depreciated on a 39-year schedule, while apartments and other residential real estate are depreciated over 27.5 years, said Mark Lumpkin, owner of the Lumpkin Agency in Baton Rouge. But since 1997, the Internal Revenue Service has allowed commercial property owners to accelerate the write-offs for parts of the buildings into three-, five-, seven-, 10- and 15-year schedules.
A cost segregation study, performed by a qualified engineering company, makes those allocations, he said. That means part of the building is considered five-year property, some is seven-year property and so forth.
Anything that adds to the “frou frou” side of the building, such as carpets, paint, wallpaper, crown molding, wainscoting, the specialty plumbing in restaurants and even the roll-up doors on storage facilities, can qualify for accelerated depreciation, Lumpkin said.
Lumpkin’s agency works with Cost Segregation Services Inc., also known as CSSI, a Baton Rouge company that is one of the more active cost segregation companies in the country, he said. CSSI has done more than 6,000 cost segregation studies nationwide in the past decade.
William Becker Jr., a partner in Tampa-based accounting firm Cherry Bekaert LLP, said the amount of property that is reclassified to short-term assets varies depending on the building’s use.
For example, a medical office building will have a much higher percentage of short-term assets than a typical office building even if the structures are identical on the outside, Becker said. That’s because the medical office building includes things like wiring and emergency circuits for medical equipment and additional plumbing.
Typically, 10 percent to 20 percent of the property may be reclassified as short-term assets, Becker said. Manufacturers may have 60 percent reclassified as short-term assets, and restaurants can also benefit greatly from cost segregation.
In the past two years, Lumpkin said, he has helped 83 companies save $6.7 million.
“It’s a lot of money,” said Cheryl Tyler, a CPA and cost segregation assistant with the Lumpkin Agency. “That’s what makes it so much fun. Instead of saying, ‘You better write a check to the IRS for $25,000,’ you get to say, ‘Whoa, look what you get to pay this year!’”
Baton Rouge developer Mike Wampold said he began using cost segregation in 2002, when he built The Shaw Group Inc.’s corporate headquarters on Essen Lane.
Wampold said he’s also used cost segregation on II City Plaza downtown and the Renaissance Hotel on Bluebonnet Boulevard.
Cost segregation probably identifies up to 20 percent of the costs of the building, say a Class A office or a hotel, that has a shorter useful life than the 39 years in a typical depreciation schedule, Wampold said. It’s not a huge percentage of the total costs, but definitely helpful.
Bob Israel, president of the Louisiana Auto Dealers Association, said cost segregation can be very beneficial to car dealers.
Almost all of the carmakers are demanding dealers upgrade their facilities, Israel said. So when dealers put up new buildings or make improvements, the studies help reduce those costs.
“I’ve been involved in recommending it for about five years, but there’s never been a better time than now to do it,” Israel said.
Ben Miller, of the Kean Miller law firm, said he recommends cost segregation to every client who buys commercial property.
Miller said he has used the concept himself on several commercial properties.
Miller said cost segregation should probably be limited to properties worth $250,000 or more. CSSI recommends the studies for properties valued at $300,000 or more.
“We’ve had buildings down to $200,000 that it was definitely worth their while to do it,” Lumpkin said.
The study for that building cost around $2,200 but reduced the building owner’s taxes by $14,000, Lumpkin said.
Lumpkin said originally only the biggest companies could afford to do cost segregations studies, which could cost $100,000 or more.
CSSI founder Jim Shreve, an engineer and economist, helped develop an affordable method of doing the studies, Lumpkin said.
Shreve could not be reached for comment for the story, but Lumpkin said Shreve’s work has made the process much more economical.
Becker said the price for the studies has come down dramatically over the past 11 years as the practice has become widespread and more engineers do the work.
Early on, engineers were commanding much higher fees for the studies than now, Becker said. These days a study for a small office building might run $7,000 to $8,000; 10 years ago the cost would have been $18,000.
Also driving prices down, unfortunately, is the influx of companies doing cost segregation studies that aren’t engineering-based, Becker said. These companies do “residual studies,” identifying short-term assets and lumping everything else into the long-term category.
The firms charge less, but they may also overstate the short-term assets, Becker said. Their studies may or may not stand up to IRS scrutiny, which leaves the property owner vulnerable to audits and additional tax payments and possibly penalties.
But lots of people are willing to take that risk, Becker said.
Lumpkin said the size of the market for the service is “unbelievable.”
“I think 80 percent of people haven’t done this,” Lumpkin said.
Brad Seguin, owner of Seguin Pools and a contractor with CSSI, said he began doing cost segregation work about three years ago after hearing about it.
Seguin figured he could do the cost segregation during the winter when the demand for pools is lower, creating a steadier income stream.
A lot of the work he does involves educating a property owner’s CPA about the process, Seguin said, and convincing the accountants that he’s not trying to steal their clients.
Seguin said he and other contractors with CSSI aren’t accountants.
“That’s not what we do. We’re consultants. We can help them with their clients,” Seguin said.
Lumpkin also said a lot of his time is spent on getting the word out, selling the idea to property owners and their accountants.
“We’re spending more time with them, educating them about it,” Lumpkin said. “Some CPAs say, ‘Oh, it’s only good for new buildings.’ Some say, ‘It’s only good for old buildings,’” Lumpkin said. “Well, it’s good for old buildings and new buildings. There’s a lot of misconceptions.”
Lumpkin hired Tyler at the end of May, after weeks of trying to sell her on the idea, to help him better communicate with CPAs. At the time, Tyler was working for the state Legislative Auditor’s Office.
Tyler said she doesn’t know exactly why more CPAs aren’t recommending cost segregation. One reason may be that CPAs are naturally conservative, and most of them have the same problem she had with cost segregation, Tyler said.
“I just thought it sounded too good to be true, and you know the saying … ‘it probably is,’” Tyler said.
But after studying the issue, looking at the IRS website to get the agency’s opinion on cost segregation and examining the IRS audit techniques as they apply to the practice, Tyler was convinced.
The IRS says a cost segregation study has to meet 13 elements to be recognized; CSSI’s studies meet or exceed each of those standards, she said.
Tyler said the preliminary property analysis, which shows the estimated tax savings, is free.
All the agency needs is the property owner’s depreciation schedule, she said.
Getting that schedule isn’t always easy, Lumpkin said.
“Sometimes it takes forever to get that from the CPA. Sometimes we’ll get it like that,” he said, snapping his fingers.
Once the agency gets the depreciation schedule, it can run the analysis, Lumpkin said. After that, the only question is whether the property owner will do a cost segregation study, and upwards of 70 percent do.
Tyler said the agency has had several clients who decided to wait a year before taking the depreciation because they didn’t have enough income for the current year.
“But you never lose it. You can carry this loss forward. It doesn’t disappear,” Tyler said.
The cost for the service depends on the amount of work involved, she said. An apartment complex takes more time than a mini-warehouse or storage units.
A properly done study means someone — CSSI has people all over the country — has to go through the building taking pictures of everything inside and out so that it can be properly allocated, Lumpkin said.
Lumpkin said the cost segregation business is a lot of fun, and it has changed his relationship for the better with a number of clients.
“It’s like Cheryl said. You bring good news,” Lumpkin said.
“It’s like Christmas,” Tyler said.