Perhaps no other industry stands to benefit more from cost segregation studies than the manufacturing industry. With the accelerated depreciation that cost segregation allows, you can increase tax deductions and pay less tax during the early stages of a property’s life, resulting in increased cash flow. Even if you built or purchased your facility several years ago, the benefits of a cost segregation study are not lost.
What is cost segregation?
Cost segregation is a tax-savings strategy that involves a comprehensive analysis of capital expenditures related to your property. The study identifies all of the different non-structural elements that go into your property – ranging from electrical to plumbing costs – and reclassifies them so they can be depreciated over shorter timeframes. Accelerating depreciation on your real estate investment results in increased tax deduction and less taxes in the early stages of a property’s life, thereby increasing cash flow.
How the Cost Segregation Process Works for Manufacturers
In manufacturing, what may appear to be structural elements of a facility – steel and concrete – may actually be considered short-lived equipment costs if they exist solely to support the manufacturing equipment within that facility. Additionally, building systems, such as plumbing, HVAC and electrical systems used to support, maintain or operate manufacturing equipment may also qualify as short-lived property in many instances.
In studies our team members have performed, light manufacturers have benefited by reclassifying anywhere from 15% to 40% of the depreciable cost of a facility to a shorter tax life. Heavy manufacturers have been able to reclassify 25% to 70% of the cost to a shorter tax life, and processing plants often can reclassify 60% to 90% of their facility depreciable cost to short-lived property.
Example of a Cost Segregation Study
The best way to understand the potential tax benefits of a cost segregation study is to look at an example. Assume a $5,000,000 facility was placed in service by a taxpayer and depreciated over 39 years in 2008. Assume further that a cost segregation study was performed in 2013, and as a result, 30% of the building cost was reclassified to a 7-year property and 15% was reclassified to a 15-year property.
By filing for a tax accounting method change in 2013 to reflect the cost segregation report, the taxpayer would have an additional $1.3-million-dollar tax deduction to reflect the missed depreciation expense from prior years. At a 40% tax rate, that’s $520,000 taxes not paid in 2013. Assuming a 6% borrowing rate, the net present value of accelerating the depreciation deductions for this taxpayer would be approximately $370,000.
Depreciation Deductions Now Vs. Later
As tax rates increase, so does the value of your tax deductions. Even though a cost segregation study allows you to “catch-up” your missed depreciation from prior years, you still get to take the deduction at today’s tax rate – not what the rates were when the facility was first placed in service.
Since cost segregation only accelerates the tax deductions you would have over a 39-year timeframe, each year that passes reduces the net present value benefit of taking tax depreciation deductions now instead of waiting for them.
Cost Segregation at RKL
To maximize your tax savings and meet complex compliance requirements, it’s essential to work with experienced cost segregation specialists. RKL stands apart in Central and Eastern Pennsylvania for our history and expertise in providing cost segregation services to the manufacturing industry. Before engaging in the study, we will provide you with an analysis of benefits based on our experience with other projects that have similar characteristics.
Interested in learning more about how a cost segregation study might benefit your manufacturing company? Contact Steven E. Fisher, partner and leader of RKL’s Manufacturing & Distribution Services Group, at firstname.lastname@example.org or (610) 376-1595.
Contributed by Robert M. Gratalo, CPA, MST, a partner in RKL’s Tax Services Group. Rob specializes in federal and state taxation of privately held businesses in the construction, manufacturing and distribution, real estate development, architecture and engineering and service industries.