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February 2004
Portfolio Management: Divide & Profit
By Paige Orr
Property owners may have hundreds of thousands of dollars in cost savings just waiting to be tapped. With careful study, building owners may be able to use a tax strategy called “cost segregation” to free up money early by depreciating parts of their buildings almost six times faster than old tax laws allowed. Through cost segregation, items such as office equipment, landscaping and electrical wiring can be depreciated faster than real property. Businesses can depreciate these elements of construction and building costs in five to 15 years, compared to the 39 years for real commercial property and 27.5 years for residential rental property, according to Jimmy Rodefer, chief executive of Knoxville-based Rodefer Moss accounting firm. Major savings come from the latest federal tax law changes, which increase the benefit with 50% bonus depreciation on qualifying new property placed in service after May 5, 2003. An earlier change allows for 30% bonus depreciation on property that generally came into use on or after Sept. 11, 2001, and before May 5, 2003. For example, if 20% of a new $2.5 million property is segregated and depreciated at a seven-year rate—and it qualifies for the maximum bonus depreciation deduction—the cash benefit can be almost $95,000 more than if the entire property was depreciated over 39 years A more aggressive cost segregation could save even more. New tax laws also make it easier to change the depreciation classifications of assets placed into service in prior years without amending past tax returns. While the cost savings may not be the wind-fall property owners can realize with bonus depreciation deductions, experts say it’s still worth the time. Methods to allocate costs separately have been used for years, and they received added attention in 1997 when Nashville-based hospital chain HCA won a long-fought legal battle. The U.S. Tax Court ruled that certain property is eligible for federal income tax depreciation at a faster rate than that of a building. Subsequent tax law changes have drawn more attention to the strategy, but not all property owners are taking full advantage of cost segregation. Rodefer says about 20% of clients and potential clients have a good idea of what this process means. About 25% have heard of cost segregation, and it’s news to the rest of them. His accounting firm, like many others, offers cost segregation services. Rodefer Moss is marketing its access to a team of engineers and accountants who focus on cost segregation, available through Rodefer Moss’ new membership in BDO Seidman Alliance, an association of more than 100 independent accounting firms. Rodefer says cost segregation analyses usually result in a savings that more than covers his firm’s fees. Trey Rochford, vice president of Nashville-based Rochford Realty & Construction and a retired certified public accountant, says he was able to classify about 12% of the company’s Hampton Inn & Suites hotel cost as “other than real property,” resulting in a more rapid depreciation on items such as the phone system, landscaping and the parking lot However, because the hotel opened in 2000, it does not qualify for the bonus depreciation. “We weren’t as aggressive as we could have been because we would rather not take a certain deduction than take it and have to defend it later,” Rochford says. “I would urge caution for anyone looking into this. There is a benefit to be found, but you need to be careful that you can justify your positions. “This is a very complicated procedure that probably should not be undertaken without the benefit of a CPA who knows what he or she is doing,” he adds.
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