The value of cost segregation for manufacturing facilities

By Israel Segal

Manufacturing facilities can reduce their taxes significantly through a process called cost segregation. According to federal tax laws, cost segregation consists of identifying personal property assets that are grouped with real property assets, then separating the personal assets for tax reporting purposes. Doing this requires an experienced engineer with a well-rounded understanding of construction finance who can produce a cost segregation analysis that identifies and classifies personal property assets. Personal property consists of a building’s non-structural elements, exterior land improvements and indirect construction costs.

The engineer must examine blueprints, architectural drawings and electrical plans and isolate structural and mechanical components from those that are considered personal property. The cost segregation report will also identify architectural and engineering fees that can be segregated. 

A well-documented and thorough cost segregation analysis will:

  1. Maximize tax savings by adjusting the timing of deductions.
  2. Create an audit trail to help resolve IRS inquiries. 
  3. Take advantage of retroactive benefits. Manufacturers can capture immediate retroactive savings on property added since 1987. The rules have been amended so that you can now take the full amount of an adjustment in the year the cost segregation is completed. 
  4.  Provide significant opportunities to reduce real estate tax liabilities.
  5. Under certain circumstances, permit manufacturers to qualify for a special 30 percent bonus depreciation allowed by the Job Creation and Worker Assistance Act of 2002 or a 50 percent bonus depreciation allowed under the Jobs and Growth Tax Relief Reconciliation Act of 2003.

The cost segregation study will identify building costs that would normally be depreciated over a 27.5 to 39-year period, then reclassify those costs, resulting in an accelerated method of depreciation. Non-structural costs for items such as carpeting, wall coverings, some aspects of an electrical system, decorative lighting, indoor and outdoor plants, sidewalks and landscaping can all be depreciated during the much shorter periods of five, seven or fifteen years.

The larger tax deductions will result in increased cash flow and a lower cost of capital, especially during the first few years following an expansion project, renovation or purchase. A cost segregation study can help identify opportunities for such periods of accelerated depreciation.  

In order for manufacturing facilities to take full advantage of cost segregation opportunities, buildings must have been purchased, constructed, renovated or expanded after 1987. While cost segregation is most cost-effective for such buildings, a well done study can uncover tax deductions for buildings that predate 1987. Buildings best suited for cost segregation will have a cost basis greater than $500,000.

Cost segregation examples:

  • An individual purchases a manufacturing facility for $10,000,000 while the land is owned by another entity. If the purchaser does not use cost segregation, then straight-line depreciation over 39 years must be used. If, however, an engineer produces a report that shows that, of the total purchase price, $9,000,000 is for the building, $800,000 is for a parking lot, and $50,000 is for landscaping and shrubbery, the facility owner could save more than $100,000 assuming a tax rate of 35 percent and 5 percent discount rate.
  • A cost segregation analysis shows that a building’s siding had an initial value of $200,000. Five years later, it has a value of $150,000 and must be replaced. The manufacturing facility owner could deduct $150,000 as a loss. Without a cost segregation study, the owner would not be able to take the deduction because the siding’s tax basis and the cost basis of the building would not have been itemized as separate entities.

A cost segregation study is an essential fiduciary component when:

  • Building a new manufacturing facility
  • Acquiring an existing building
  • Renovating an existing manufacturing facility
  • Expanding a manufacturing facility

Not conducting a cost segregation analysis in these circumstances can cost owners significant tax benefits.

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Isreal Segal is president of VFR Finance                                                                                                                News around the Web

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