In my previous blog, I introduced the concept of cost segregation studies and their potential benefits for manufacturing businesses. Now, let's get into the nuts and bolts of the actual process. Understanding what to expect can help you determine if this is the right strategy for your operation.Editor's Note: This blog post is adapted from a transcript of our Manufacturing Minute podcast episode featuring John Hanning of Specialty Tax Group. The content reflects the conversational nature of the original recording.
The Classification Framework
One of the most important questions I asked John Hanning was how they actually determine the classification of assets between personal property, land improvements, and real property. The answer lies in IRS Publication 946.
Within Publication 946, there are two critical tables: B1 and B2. Table B1 defines specific assets with clearly identified recovery periods. For example, anything supporting computers or information systems falls into asset class 0012 and is recovered over five years.
Since the IRS can't list every asset in existence, Table B2 covers nine pages and focuses on assets used in the activity of a certain process. The key is matching your activity to the appropriate classification, then determining the proper recovery period for each accelerated personal property item.
Following the Audit Techniques Guide
While Publication 946 provides the tools, the methodology comes from the Audit Techniques Guide, or ATG. This guide outlines six approved methodologies and establishes what the IRS considers a quality study.
The approach varies depending on your situation. If you acquired a building, you might not have blueprints or original construction costs, but you'll have a closing statement and perhaps a property condition report or appraisal. In these cases, cost estimates recreate the assets using nationally recognized costing models. This approach is called the Detailed Engineering Cost Estimate Approach.
If you built the building, you likely have drawings and detailed cost records, allowing for a full engineering study with actual costs. This approach is called the Detailed Engineering Approach from Actual Cost Records. Either way, the goal is delivering an audit-ready report that you and your CPA can rely on with confidence.
What Documentation Do You Need?
As someone who works with controllers regularly, I know everyone is stretched thin. The good news is that while the documentation list might seem extensive, the process is manageable with the right guidance.
For acquisitions, the team will request items like property condition reports, ALTA surveys, appraisals, and closing statements. For new construction, they'll want AIA forms (General Contractor's 702 & 703) showing trade-by-trade detail, your general ledger with capitalized costs, and as-built plans if available.
John emphasized that his team walks you through every bit of this process. They conduct a site visit with every project, which the ATG requires for quality studies. They want to see how things are used in your business and understand the manner of attachment. Usually, a 30-minute conversation can gather everything needed to move forward.
Timeline and Deliverables
The typical timeline runs between 30 and 60 days, though with an engaged client and good building access, this can be shortened considerably. John's team has developed internal software that streamlines the process, and they can turn projects around quickly when needed.
The final deliverable includes an audit-ready PDF report of approximately 100 pages, explaining the methodology and supporting all calculations. You'll also receive an Excel file with all units of property that have been split out and accelerated, formatted for easy upload to your depreciation schedule or fixed asset software. No more keying errors or manual data entry.
Real Tax Savings
The potential savings are substantial. With 100% bonus depreciation at play for 2025 and permanently beyond, John reports seeing between 20 and 25% of the basis amount accelerated in the first year. For a $10 million manufacturing facility, that represents significant income elimination and cash flow improvement.
Understanding the Risks
Of course, no tax strategy is without considerations. John was refreshingly honest about situations where cost segregation doesn't make sense. If you're not generating income, accelerated deductions won't help you. If you're only holding the property for a short time, the time value of money benefit diminishes, and you could face unfavorable recapture situations.
The key is working in concert with your CPA to ensure this is the right tax strategy for your specific situation. Even if you're in a loss position today, you can conduct a study later when you're profitable. The catch-up method allows you to claim all missed depreciation in the year of change without amending prior returns.
The Current Manufacturing Landscape
Here in Southwest Virginia, every conference and news blast from the Virginia Economic Development Partnership talks about expansion and bringing manufacturing back to domestic locations. There's tremendous momentum for reshoring manufacturing jobs, and the tax code incentivizes this activity.
For new and expanding manufacturing businesses, cost segregation represents a straightforward process with true cash tax savings. The benefits of conducting these studies are tremendous, especially when clients engage in proactive discussions early in their planning process.
As CPAs, we follow the rules, but it's also our job to provide tax savings and tax planning. Identifying opportunities like cost segregation through proactive communication with your accounting team is priceless. Whether you're working with overseas ownership, private equity, or local investors, these studies can significantly impact your cash position.
Cash is king, and anything we can do to help our clients keep more of it—whether for investing in AI, hiring new positions, or expanding operations—is worth exploring.
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