Choosing the Right Cost Segregation Company: Fact vs. Fiction 

Cost segregation is a powerful tax strategy for owners of commercial and residential investment real estate properties. By reclassifying certain building components with shorter lifespans, this technique accelerates depreciation deductions, potentially saving property owners thousands, even millions, in taxes.

However, the growing popularity of cost segregation has led to an increase in providers and technologies striving to offer fast and inexpensive reports entering the market. These firms often lack the qualifications to perform these complex studies. Making matters worse, the IRS is increasing its scrutiny of cost segregation studies. Engaging an unqualified firm can lead to substantial financial penalties and headaches with the IRS.

Let's delve into how you can protect yourself and make sure you choose a reputable, experienced cost segregation firm.

Understanding Cost Segregation

Cost segregation is the process of meticulously examining a property to identify components that can be depreciated over shorter periods than the standard 39-year timeframe used for commercial buildings. Examples include specialized electrical systems, decorative lighting, flooring, certain plumbing fixtures and even landscaping elements.

Imagine you purchase a commercial building for $5 million. Traditionally, you would depreciate the entire building basis ($5 million minus land value) over 39 years. But with a cost segregation study, some percentage of your building's cost (often 20-40%) could be reclassified into those shorter lifespan categories. This means you might deduct a million dollars or more within the first few years of ownership instead of spreading that deduction thinly over decades.

This accelerated depreciation has an immediate positive impact. It results in substantial tax savings due to your lower taxable income. It also increases available cash flow, which you can use to invest in your business, acquire additional properties or boost returns to investors.

It's important to understand that cost segregation is a legitimate and IRS-approved tax strategy (to learn more read: Cost Segregation Audit Technique Guidelines). A well-conducted study is your ticket to maximizing deductions while staying fully compliant with tax regulations.

The Rise of Sub-Par Providers

The potential for significant tax savings has understandably fueled the popularity of cost segregation studies. Unfortunately, this has also led to a proliferation of firms and marketing entities entering the market without the necessary qualifications or expertise. These providers may offer tempting low fees or exaggerated promises, but they often lack the experience to create studies that can withstand IRS scrutiny and generate significantly less benefit than a more comprehensive study. 

The consequences of working with an unqualified firm can be severe, including:

• IRS audits and penalties: Poorly conducted studies may be riddled with errors and unsubstantiated assumptions, leading to costly audits and substantial financial penalties. The IRS can disallow deductions, impose interest charges and even levy accuracy-related penalties.
• Missed opportunities: Inexperienced firms may overlook numerous eligible components because they lack the knowledge or simply don't perform a thorough enough analysis. This can result in leaving a significant amount of potential deductions—and significant tax savings—on the table.
• Long-term headaches: Dealing with IRS audit fallout and correcting inaccurate studies can be a drawn-out, stressful and expensive process. It can take years to resolve an audit, and the costs for professional assistance to navigate these challenges can be substantial.

Qualifications of a Reputable Firm

Finding a truly qualified cost segregation provider takes some due diligence. Here are the key credentials you should look for:

• Licensure and experience: Choose a firm with licensed engineers and tax specialists. The IRS recommends that a licensed engineer or other qualified professional should perform cost segregation studies. Beyond licensure, look for years of industry experience with the complexities of cost segregation.
• In-house engineers: The best firms have specialized engineers on staff, not just hired contractors. The company should visit the property in person, ensuring thorough analysis and accurate identification of eligible components. This approach will usually generate 20%-25% more first year benefit from a simplified study. And the additional savings exponentially pays for the small additional cost of a quality report. 
• IRS and industry compliance: Select a firm with a strong track record of delivering IRS-compliant studies. Ensure they are up to date on the latest changes in tax regulations, construction accounting practices and audit procedures.
• Experience with your Specific Type of Property: Not all property types are the same and unique property types such as self-storage, mobile home parks, restaurants, car washes, and gas stations are some examples where the IRS ATG’s have specific rules that may apply differently from a typical commercial building. 

Remember, price shouldn't be your primary concern. A well-qualified firm, while not the cheapest option, can deliver significantly greater tax savings and will provide invaluable peace of mind during a potential audit.

Spotting the Red Flags

Now that you know what to look for in a qualified firm, let’s examine some red flags to be warry of. There are a few telltale signs that should raise your suspicion and prompt further investigation before hiring a cost segregation firm. Watch out for:

• Lack of transparency: Reputable firms are open about their qualifications, processes and pricing. If a firm avoids providing detailed information or their answers seem evasive, consider it a warning sign.
• Too-good-to-be-true promises: Be wary of firms guaranteeing unrealistic savings or unusually low fees. If it seems too good to be true, it probably is.
• Insufficient documentation: A proper cost segregation study results in a comprehensive report (often over 100 pages long) with detailed calculations and supporting evidence. Firms that offer thin reports or lack documentation likely cut corners during the process.
• Don't simply trust a website: Nowadays a website can be created in minutes, claiming many years of experience, when in reality, the company might be 6 months old. Audit support is only good as long as the company remains in business! Get references or verify the validity of their claims. 

The Right Questions to Ask

Before engaging with a cost segregation firm, make sure you ask the following essential questions:

• What are the specific qualifications and experience of your engineers?
• Does your firm conduct the entire study in house?
• What is your process for site visits?
• How do you handle IRS audits?
• Can you provide a free benefit analysis for my property?
• Is your estimate based on conservative or aggressive projections? 
• What land allocation are you using? 
• Does the study break out all of the structural property (including electrical, plumbing and mechanical systems) in addition to the personal property asset?
• Can you provide a sample redacted report from a previous study?
• Do you have experience with properties similar to mine?

Don't be afraid to ask detailed questions and request further information if necessary. A reputable firm will welcome your inquiries and help you understand the benefits and process of conducting a cost segregation study.

Conclusion

Choosing the right cost segregation firm is a critical decision for any property owner seeking to maximize their tax benefits. Don't be swayed by bargain prices or exaggerated promises. Prioritize firms with proven expertise, qualified engineers and a commitment to IRS compliance.

By conducting your due diligence and partnering with a reputable firm like Engineered Tax Services, you'll unlock the full potential of cost segregation. If you're ready to explore the benefits of this powerful tax strategy for your property, contact us today.