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November 2011 – Cost Segregation can Free-up Cash Flow

A Dollar Today is Worth More than a Dollar Tomorrow

Cost Segregation Studies Can Free Cash Flow

Weak economies slim-down profit margins, tighten credit markets, and restrict investment capital.  Under these conditions, prudent business owners look for unconventional capital sources.  One such unconventional source begins with a Cost Segregation Study (a “CSS”).  A CSS can free cash for capital expenditures or normal operations.

Manufacturers can save on upgrading their production center; retailers can fund new/improved storefronts in existing and new markets; shopping malls or office building can remodel to lower energy costs and attract new tenants.  The possibilities seem limitless.  Interestingly, CSSs can enhance a business with no expansion/updating objectives too.

CSSs are technical tax componentizations applied to commercial buildings constructed, remodeled, expanded or purchased since 1987.  CSSs can result in sizeable tax savings by accelerating depreciation allowances. Even the U.S. Treasury Department advised in the Wall Street Journal that CSSs “should be considered in almost every real estate purchase.”

Whether or not you’re considering a real estate purchase – or recently made one – multiple reasons exist for considering a CSS.

A CSS segregates the costs of various building parts/components.  This permits classifying certain parts/components as “personal property” or “land improvements” rather than “real property.” This classification reduces your tax bill by accelerating available depreciation deductions.

Real property depreciation is figured over extended lives (as long as 39 years).  Long lives mean small depreciation deductions.  Personal property depreciation routinely entails substantially shorter depreciation lives such as 5, 7 and even 15 years. Shorter lives mean larger depreciation deductions.  “A dollar in your pocket today is worth more than a dollar in your pocket in 2050.”  Consequently, reclassifying $100,000 worth of lighting, plumbing, HVAC and other such assets as five-year personal property (as opposed to real property) creates roughly $16,000 in net-present-value tax savings (assuming a 5% discount rate and a 35% marginal tax rate).

Newly constructed improvements may qualify for either bonus depreciation or expensing under IRC §179. In any event profitable manufacturers moving to new facilities may find a CSS’ results partially funding the costs of buying and renovating the facility. A business with a net operating loss (aka NOL) may be able to carry back the CSS generated depreciation losses and secure cash refunds of prior year taxes.

A peripheral benefit of reclassifying building components as personal property may permit real property value reductions for “property tax” purposes. And CSS componentization simplifies writing off the lighting, plumbing, HVAC or other such assets when they are replaced or become obsolete.

Be Proactive!

The IRS requires thorough and detailed records for CSSs to achieve their desired results.  Hence, a CSS specialist becomes indispensible. In new construction early specialist involvement assures more suitable documentation respecting personal property’s use and cost. Specialists also assist your architects or engineers with creating necessary information and documentation. This is particularly valuable in constructing complex and highly detailed buildings.

CSSs are both possible and valuable after construction is complete.  Success in this setting depends on recognizing, documenting and valuing all building components so the reclassification is approved by the IRS.  In this setting IRS approval is necessary.  Here is where the specialist really proves his/her worth.

CSSs can be applied to most types of commercial buildings, but conventionally CSSs are most valuable regarding specialized buildings such as manufacturing and processing plants, hotels, banks and apartment buildings.

A CSS may be just the cash flow boost you business’ has been seeking.

To learn more about CSSs and how they may favorably impact your business, contact Stephen C. Smith or your Holbrook & Manter representative before attempting any CSS.  We facilitate CSSs for growth-minded clients.

TAGS:  Depreciation; capital investment; business planning;