Accelerated Cost Recovery: Cost Segregation Study Helps Increase Developer’s Cash-On-Hand

Background

Flaherty & Collins, headquartered in Indianapolis, is one of the largest multifamily developers in the Midwest. In the last 30 years, F&C has completed over $2 billion in development. They also manage 76 properties across seven states. With an ongoing pipeline of $500 million in development, F&C is a leader in the development, construction, and management of multifamily properties.

The Challenge

In 2019, F&C placed into service a multifamily and retail mixed-use development in downtown Elkhart, Indiana, called Stonewater at the Riverwalk. A cost segregation study of the property was needed to identify costs that could potentially be reclassified in order to minimize the tax burden.

The Solution

Katz, Sapper & Miller was engaged to perform a cost segregation study for the Stonewater at the Riverwalk property. This study identifies costs that can be moved from the owner’s building basis, which is depreciated for tax purposes at 30 years for multifamily properties, to a more favorable asset classification of either land improvement, depreciated over 15 years, or personal property, which is depreciated over 5 or 7 years. Both personal property and land improvements also qualify for 100% bonus depreciation for federal tax purposes.

The study requires a combination of engineering and accounting expertise, as it involves review and analysis of accounting records, technical documents like construction blueprints and system schematics, and an onsite property tour to accurately identify components of a building that can be depreciated over shorter lifespans. The study will not increase the total amount of depreciation that can be claimed over the life of the property, but it can significantly accelerate the recovery of costs into the early years of the asset’s life for tax purposes.

Throughout the course of the study, KSM’s team set out to perform the following services:

• Thoroughly review construction blueprints and other project documents
• Conduct a tour of the property
• Analyze actual cost records relating to the construction of the development
• Perform an engineering analysis to determine the cost and proper classification of various assets
• Examine accounting records and policies to identify the depreciable lives applicable to the property
• Identify soft costs and properly allocate them among the construction cost categories
• Deliver a written report of the findings that documents the study process and results and meets the “13 principal elements of a quality cost segregation study” set forth by the Internal Revenue Service

The Result

KSM’s cost segregation team, led by a licensed engineer and a certified public accountant, was able to reclassify over $8.3 million worth of construction costs as land improvements and tangible personal property. When combined with the 179D deduction for energy efficient buildings that our team helped F&C calculate, the increase in first-year depreciation was over $8.5 million.

KSM also provided F&C with a thoroughly documented report of the findings that meets the “13 principal elements of a quality cost segregation study” set forth in IRS guidance. In the event that the accelerated deductions are ever questioned, the IRS has stated that, “Quality studies greatly expedite the review, thereby minimizing the audit burden on all parties.”

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