Often Overlooked: Cost Segregation

So before we get going today, I want to give everybody a quick update: The last podcast, I teased the fact that we’re going to have a virtual conference coming up. We do have the registration page set up for that now. So I want to give you that, but it’s The Unique CPA Virtual Conference. The website is Tri-Merit.com/virtual-conference, and you can go there and register. We are calling it, like I said, The Unique CPA Virtual Conference, we’re gonna be talking about “recharge, refocus, and refine,” let’s get ready for this next tax season, which is hopefully going to be more normal than we’ve seen in the last two.

And I just want to give you a quick update on who the speakers are, because I am extremely thrilled with this. All of the guests have been on The Unique CPA and I just feel very fortunate that I’ve been able to talk to these individuals, because they’re great national speakers. And the first is John Garrett, and John’s gonna be talking about the lifetime value of employees: attracting and retaining engaged talent.

And then Jordan Goodman in Jordan is a well known SALT expert, and he’s going to be talking about Nexus, post wayfair and pandemic, do I really have to file everywhere on everything? Which is going to be a pretty interesting topic when we’re talking about SALT issues.

Kristen Rampe is gonna be talking about partner compensation: more performance and less agony.

I will actually be talking as well, about permanent tax incentives and credits, what your clients need to know, post-COVID relief. So let’s get prepared for this third tax season, and what are the credits and incentives out there available for taxpayers, one of which we’re talking with today, with Craig Tobin on the show.

And then our next speaker is going to be Josh Lance. Josh is going to be talking about building a niche virtual practice.

We will end up with Nick Pantaleo from Tri-Merit, who will be sharing results of our benchmark survey on R&D tax credits.

And at the end of the day, we will have a virtual happy hour and beer tasting. This is an optional event; this part of the event will be paid. The rest we are bringing to you at no cost this year, just as a thank you and the, “let’s, you know, glad we made it all through, all made it through the last year and a half, And now let’s get prepared for moving forward.” So just a quick teaser on that, and now we will get back to the show.

Today, our guest is Craig Tobin, Craig has over 35 years’ experience in the valuation of real estate for a wide variety of tax purposes. He actually has a bachelor’s degree in architectural engineering from the Milwaukee School of Engineering. And I have known Craig for, well, I would guess it’s three or four years. I’ve known of Craig for longer than that through a mutual friend, and I was really glad when I reached out to him, and we were started doing some work together. So Craig, I’d like to welcome you to The Unique CPA.

Great, thank you very much. I appreciate that.

Yeah, it’s great to have you here. We have been talking about this for a while getting you on and I think the timing’s good. But before we get into that, quickly, I mentioned 35 years. That’s—I’m not saying you’re old—but that’s being in the industry for a while. And so I’m just curious, going from a degree in architectural engineering, to work in and really in the tax field of that engineering, that degree, how did this all start?

It actually started towards the end of my senior year at MSOE. As engineers, we probably need a little polish and a little practice how to go for an interview, and so I interviewed with a company called American Appraisal at that time, who back in those days was the largest valuation firm in the world. And it was very interesting, there was a lot of travel involved. Of course, I’m coming out of school at 22 years old, and thought “that’d be fun.” So I ended up taking that position with them to find out that the traveling was brutal, and hence, not just doing—back in those days it was referred to as “Investment Tax Credit,” where today it’s now “Cost Seg,” but different types of valuation.

Most of our clients were larger: General Electric, General Motors, Pratt and Whitney, so a lot of larger manufacturing type properties for valuation purposes. And so I actually got more involved in Investment Tax Credit and Cost Seg to curb some of the travel. Because we had the benefit of working from construction drawings and construction costs, and just made for maybe a little better family life. Still a lot of travel, but not the amount of travel that we were doing internationally back in those days.

So considering Cost Seg is a national service, it keeps me in the US. So that’s a plus.

Yep.

So as I mentioned, it started out as Investment Tax Credit. Tax lives have changed over the years, lots of changes. We saw just a whole bunch of positive changes that came about in the last four or five, six years for tax payers, which is great. And so I’d like to talk about that a little bit.

Yeah, let’s get into that a little bit, and let’s set the stage of why we’re talking about this. And I think that’s important. Before I set the why, I’m just curious, when did it go from Investment Tax Credits to Cost Seg? Was there a definitive line or did it just more from one to the other over time?

It actually changed in the 90s.

Okay.

And the terminology changed. With Investment Tax Credit, it used to get a 10% deduction, right up front. And so that kind of went away with Cost Seg, the lives changed from basically 31½ years to 39 years in the 90s. And so there was a lot of changes and plans.

That’s fine. And I do recall, so I started a public account in the late 80s. And that was funny because I forgot about the 31½ 39. But that was a significant change that was in my life span of public accounting.

[bctt tweet=”With Investment Tax Credit, it used to get a 10% deduction, right up front. And so that kind of went away with Cost Seg, the lives changed from basically 31½ years to 39 years in the 90s.” username=”Tri-Merit”]

Alright, so let’s set the stage here, then, why are we talking? I mean, you know, this is The Unique CPA, we’re obviously, our audiences is CPAs. And so I think the important thing, and this is going to be a theme for me going forward quite a bit this fall, either on this show or with my webinars, is clients have become used to credits and incentives through all the Coronavirus legislation that has come through—the CARES Act, of the American Rescue Plan and the Consolidated Appropriation Act—and I went in not the correct order in those three, but those are three significant things that came out. And now we have an infrastructure plan coming out shortly as well, as it looks like.

But clients, they’re used to the PPP, the EIDL, the child tax credits, the Employee Retention Credit. They’re used to incentives being out there, where maybe they weren’t as used to that before. And so what I want to do going forward is, you know, we’re about to enter our third pandemic tax season, but I think it’s going to be more normal. And so what I want to do going forward is, let’s start setting the stage of, there are credits and incentives out there that are not related to Coronavirus. And obviously, Cost Segregation is one of those.

So let’s get into that discussion of what Cost Seg is, and the benefits, and like you were just starting to say some of the major changes that have happened. So I’ll open the floor to you and if you just want to give us an education on Cost Seg, it’s all yours.

Absolutely. And this could not be a better time to take advantage of acceleration for federal tax depreciation. All of the variables are positive. We have 100% bonus depreciation on any assets that have a life class less than 20 years, which means that all the land improvements, all the personal property, other tangible property associated with real estate is going to qualify for this 100% bonus, which means that you can write off those costs or values in the first year.

[bctt tweet=”And that’s the neat thing, too, which has changed most recently is that bonus depreciation not only applies now to new construction, it also applies to acquisitions, which none of us were used to up until a couple years ago.” username=”TriMerit”]

And that’s the neat thing, too, which has changed most recently is that bonus depreciation not only applies now to new construction, it also applies to acquisitions, which none of us were used to up until a couple years ago. So two really positive things—bonus depreciation, bonus depreciation applying to acquisitions—and the other greatest thing that’s out there, one other great thing, is QIP, Qualified Improvement Property. So they seem to have that in place. Now QIP basically takes the place of qualified leasehold improvements qualified retail—

—Was it qualified restaurant improvements, I think? Yeah, there was three things three things are rolled into one, and the QIP—the interesting thing with that, sorry, cutting you off, I don’t want to steal your thunder, you know your stuff—but the interesting thing about the QIP is that was where the mistake happen in the Tax Cut and Jobs Act where it got defined with the wrong lifespan, and we had to have a pandemic to get that fixed and that came out in the CARES Act where they fixed the lifespan on that, and so now that is eligible for bonus depreciation. Sorry, I’ll let you continue.

Yes, exactly. So I mean, this is things that have occurred now in the last couple of years. So, you know, for a lot of taxpayers, you know, they hear about it, but they’re not quite sure exactly what that means, and how does that apply to them. And that’s where, you know, of course, this podcast is going to help them a little bit to raise questions. Of course call us if you have, you know, specific questions.

But the neat thing with QIP, is that just like you said, Randy—it’s not 39 years anymore. It’s a 15 year life class. So obviously, 15 years is less than 20, which qualifies for 100% bonus. But what is QIP? Well, QIP is the construction within the, we’ll say, the shell of an existing building. So it has a constraint, obviously, it’s new construction. And it includes things like drywall partitions, light fixtures, HVAC, fire protection—all the things that typically would be 39 years. It’s a building component. But if you’re installing it within an existing building, it qualifies as QIP, 100% bonus bonus. So it’s phenomenal.

Oh, yeah. And the one thing to point out there is commercial building, not a residential property. It has to be commercial, correct?

That’s correct. Yep. Yep. Unfortunately, for whatever reason, sorry, everyone that’s investing in apartments, no QIP. Then again, for apartments just to give them their fair share, we do a 179 D. And we have 45L. Which are other ways to accelerate your depreciation—besides Cost Seg does apply to apartments.

Yes.

So in the case of Cost Seg, and I can’t say too many times, cost sake will apply to anything that you build, buy or renovate. If you’re not looking at Cost Seg, you’re leaving money on the table. 

And to, you know, have a Cost Seg benefit, the taxpayer does have to be making some money. 

Yep.

And that kind of leads me into my other positive thing about Cost Seg, which is the fact that we can do lookbacks. Which is probably 40, maybe 60% of the work we do, are lookbacks into earlier tax years. And so, you know, just going back even to 2008, 9, 10, 11, 12—when, you know, the real estate market became a little crazier than usual—a lot of people were not making a lot of money, but they were still buying, building and renovating real estate. So they had no real reason to accelerate, because they weren’t sending any money to Washington. But now all of a sudden, that changes, even in a pandemic.

Our clients, a lot of our clients, taxpayers overall, are making money. So it gives us the opportunity to go back in time, and no amending tax returns. Did I say that? No amending of tax returns is just a filing of a change of accounting, a 3115, which I do not do, because I’m an engineer, not a CPA. But we’ll identify those costs and or values associated, you know, with that project, going back to 2008, 9 10, 11, 12. Definitely makes sense.

[bctt tweet=”The other positive thing about Cost Seg is the fact that we can do lookbacks. Which is probably 40, maybe 60% of the work we do, are lookbacks into earlier tax years.” username=”TriMerit”]

Yeah. And I think that makes a lot of sense now, too. I mean, we’re at a point in time where it appears that tax rates are going to be going up. And if we can take this this accelerated depreciation into a tax year with higher tax rates, the higher the tax rates, the more of a tax saving. So going forward with the new tax bills that are going to be proposed, you know, Cost Segregation is going to become even more valuable from the standpoint you’re going to have more cash going back into the business.

Right, absolutely. And I mean, we’re coming near the end of 2021—great time to do Cost Seg. You know, so many taxpayers are doing tax planning now. Their tax people are finding out that they purchased properties or built something or renovated it. So this is a good time to, you know, have these studies completed before we get into March and April. And/or if you’re extending, well, then it doesn’t really matter. Our timetable is your timetable.

And that’s the interesting thing as well is that during the pandemic, I think a lot of businesses took the opportunity to do renovation because they didn’t have the people in the office. And there was, I know construction people in general were pretty busy—construction companies. And so I’m thinking there’s been a lot of work done, you know, in the restaurant industry, which would be QIP eligible, but other industries as well. So it’s probably a great time to do that.

But besides that, what I want to point out—and this is so interesting, because again, I mentioned at the beginning, I’ve known Cost Seg for a long time. Never been an expert. Everything I’ve learned, you’ve taught me. I actually do education on Cost Seg now, but I’ll reach out to you to get any questions on that.

But the one thing I want to point out is that the interesting thing in talking to you, and I remember you told me this a handful of years ago, is that what you do, what you enjoy doing, is going in and basically affecting the ability to accelerate depreciation on the property, rather than just reporting what happened. And by affecting, what I’m saying is, you’re going to go in prior to the work being done, look at blueprints, and see if some minor changes can significantly increase the tax benefit. Do I have that right?

Absolutely. And Randy, we call that tax engineering. 

Okay.

And tax engineering can be totally different from one taxpayer to another. But you hit it on the head: we want to help taxpayers improve their tax position, as it relates to acceleration for depreciation purposes. So I mean, once you build the building, you’re done. You know, when we come out with our engineers, and do the inspections, and identify all the items that were change orders that aren’t on the drawings, aren’t totally broken out neatly in the cost, you get what you get.

However, if you call us before you break ground, or before you start your renovation, send us the drawings. The price is great: It’s free! So send your drawings in, and we’re gonna take a quick peek at them as part of the Cost Seg study. We’re going to possibly make some suggestions. Now not to scare anybody, we are not redesigning your building, that does not happen. 

Right, right.

What is going to happen is, we’re going to talk about how things are identified and called description-wise on the drawings in the specs, in the cost. We don’t want things that sound like building components on the drawing, and raise a red flag with the Service when they’re really personal property items, and can be removed and reused. So that’s one of the big things we’re going to suggest. 

Probably the latest thing I did last week was, we had a client call, and they were buying a building from a developer. And then they were thinking of having the developer build it out, before they actually buy the building, and just buy it as one nice, neat package. Well, that sounds like that might make your life a lot easier. However, talked about QIP—it’s got to go into an existing building. So if the developer finishes the shell and core, and you buy it, you can have the developer build it out for you, but you want it to be a separate transaction that occurs after the purchase of the existing building. Now, we’re going to move 90% of the renovation cost, or additional costs, into a shorter life class, and it’s going to qualify for 100%. The way they were going to do it as one nice, neat package, well, they probably would have ended up with 25 or 30%, qualifying for 100% bonus instead of 90%.

If you can use the acceleration, it’s just a little bit more consulting, and, like I said, how things are called, how things are attached. If you’re building a corporate headquarters, and you’re putting some great teak wood in the lobby, and it’s going to look great, well, if you glue it to the wall, it’s permanent, it’s a built-in component. Now if you hang it on on z-clips, or screw it to the wall, well, now it’s personal property.

Wow.

So let’s talk about that before you glue it to the wall.

And sometimes the flow—another great suggestion that we make, particularly in manufacturing, whether using water process waste. If you put the restrooms at the back of the facility, that means the main trunk line, because it’s serving restrooms and process, is going to go into a 39 year life class. You don’t percentage. You can’t. Not anymore.

Okay.

So what we suggest is we’ll put the restrooms at the front of the building where the water and waste lines come in. That serves the building, and then as the trunk line leaves the restrooms, it’s all process-related. It just puts us in a better position to defend those assets.

So you know, as I like to say, this isn’t brain surgery, but there are some things that most taxpayers aren’t thinking about.

Right.

So not only do we try to guide the taxpayers, there’s a lot of developers and contractors out there that have listened to your podcast, and that I’ve talked to over the years about, again, proving the tax benefits of your client. And I think they’re starting to pay attention.

Yeah, well, Cost Seg is, I think it’s a significant opportunity for taxpayers in general. I think it’s often overlooked. You know, my years in public accounting before starting Tri-Merit, I probably didn’t do nearly as many Cost Segregation or Investment Tax Credits as I probably should have. But yeah, I think that’s great

Before we close up, you know, you mentioned it pretty much, you know, you’re building, you’re renovating, you’re purchasing. Is there—are there any specific buildings or just any commercial or residential, rental? Or what would you look at?

Well, yes, there is a difference. We’re basically targeting properties that are one half of a million dollars or more. The benefit increases as the dollars per square foot increase, which typically tells us that there’s a lot more benefit. If I hear the word “warehouse,” well, the benefit’s going to be less than if I hear “medical office building,” because those two types of buildings contain a lot of different types of assets. Warehouses, you know, we’re looking at some dock levelers and some power for wrapping items up to be shipped out and power for charging up forklifts, and those kind of things. But you get into medical office buildings, well, now you’ve got lots of plumbing, you’ve got lots of power, you got lots of cabinetry: the benefit is higher.

So what we do on every project, is we’ll send you what we call a questionnaire, and it basically just asks: “Who’s the client? What’s the property? Did you buy it or build it? What did you spend?” And then we’re gonna send you a high and low benefit study, based on our experience—this is the Net Present Value of having the Cost Seg study done, and because of 100% bonus, we’re basically looking at that first year, what is the real money benefit of doing Cost Seg? And that tells all of us, “does it warrant a move forward or not?”

Our fees are not contingent, which is really too bad, because then we could charge a lot more. They’re fixed—they are based on time. And so we’re looking at our past experience saying, “Well, this is how much time it’s going to take to do the project from beginning till end.” Our fees include defending our results with the Internal Revenue Service—we don’t go through a lot of IRS audits, but there’s still randoms. 

And if you’re an insurance company, a lending institution, or a unique kind of property, such as the Cost Seg work we did a couple years ago for the Green Bay Packers at Lambeau, then yes, they come under audit right away. And so we’re there to defend that. And like I’d mentioned, we are all engineers, but we do understand that part of the tax law as it relates to acceleration and depreciation. And we have Randy as a source to, you know, keep all the engineering types up to speed as it relates to changes in tax law. So that keeps us on the cutting edge.

The person that does our studies, that engineer will also do an inspection. We inspect all of our properties, because if you get picked up in a random IRS audit, the Service will ask us three questions. The first question is, “Did you inspect the property?” And our answer is always “Yes.” “Are you the taxpayer’s brother-in-law?” The answer is always “No.” And, “Are you an engineer?” and my team and myself, we are.

Nice.

And so I like my five year old granddaughter that asked me this past weekend what type of train I drive? No, it’s not that kind of engineer. But the fact that we are engineers, we do know how to read drawings, we do understand construction, and that will improve the benefits and the percentages as it relates to these Cost Seg studies.

That’s awesome. Yeah, I’ve always been impressed with the fact that you’re not going out doing a cookie cutter Cost Seg. You’re looking at each individual building that’s got its own unique attributes and coming up with each individual thing within that, that you can accelerate.

Absolutely. And, you know, we know that those kind of providers are out there, because we compete against them, obviously. But one of my situations I had like about five, six months ago, we actually did not get the Cost Seg study because our fee was a couple thousand dollars more than this provider from out of state. But the taxpayer, because we had a relationship sent me all the drawings and the cost, so of course we could bid it, and then sent me the Cost Seg study from the competitor. And this was a Holiday Inn Express—new construction. So we had a lot of cost information, we had a full set of drawings.

And so I’m looking at the report, and I’m looking at things such as “ballroom lighting,” and I thought, “Well for all of us that travel a little bit, the last time I was at a Holiday Inn Express, they don’t have any ballrooms.” So that, you know, I’m looking at this going, “Oh, you did one hotel. It was a full service hotel—not a Holiday Inn Express or you know, a Hampton Inn or something like that—and you’re including items that don’t even exist at the property.” The other strange thing was we had the cost. Well, in Cost Segregation, hence the word cost, if you spent, for example, this client spent $150,000 on their asphalt paving. In the report by the competitor, they had $90,000, because that’s what was coming out of some quasi model—

—Averages based on, okay, yeah, yeah. 

So, they spent $150,000. So right there alone, there’s $60,000 that was lost by the taxpayer.

Yeah, the fee paid for more than itself, just there.

Absolutely.

Yep, that makes sense.

So on larger projects, we’ll send out a benefit study that says, If I find 1% more—it doesn’t have to be a huge project, just a multi million dollar project—if I find 1% more than our competitors, or someone doing the Cost Seg for you—which might be your CPA, or the contractor says they’re going to do Cost Seg—1% more far exceeds our fee. And not that I can guarantee anything. But I can guarantee you, we’re going to go 1% more, because of the way we approach the projects.

Yeah. Makes a lot of sense. Well, I think that’s great information, I think this is gonna be very helpful for people going forward. Like I said, I probably didn’t touch Cost Seg much as I should have in the past. I definitely do now. And I appreciate you being here. Before we wrap up, you want to let people know how they can get ahold of you?

Well, our best bet would be just call me on my cell phone: (414) 788-0138. Or you can contact us through our website at Tri-Merit. The best bet is either email us or just call me direct. Like I said—or as Randy kind of insinuated that I am old-er. Can’t escape the gray hair. So yeah, I’m a little more old school. I’m going to call you. And then we’re going to talk about it. But either way works. Just definitely contact us—any question you got, costs you nothing, you know, why not call? Find out what the deal is. And we are definitely here to help you.

Sounds great. Well, thank you, Craig.