As the manufacturing and distribution industry leader at Brown Edwards, I'm constantly looking for ways to help our clients maximize their financial position. Recently, I had the pleasure of sitting down with John Hanning from Specialty Tax Group to discuss a powerful tool that many manufacturing businesses overlook: cost segregation studies.
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.
If you own real estate or operate a manufacturing facility, you're likely familiar with depreciation. Traditionally, commercial buildings are depreciated over 39 years, while residential properties follow a 27.5-year schedule. Cost segregation changes this game entirely.
Simply put, a cost segregation study divvies up the components of your building into accelerated personal property or land improvement categories. Instead of waiting decades to recover your costs, you can accelerate these deductions significantly in the early years of ownership.
While cost segregation can be performed on any property, certain types see exceptional returns. Heavy and light manufacturing facilities top the list. If your building has significant processes within its structure, you're likely sitting on substantial tax savings.
John explained that they're not looking at the machinery and equipment making your widgets. Instead, they're identifying all the power and plumbing associated with your process. Medical office buildings and apartment complexes also benefit significantly, but manufacturing facilities with extensive build-outs generally see the biggest return on investment.
John shared a helpful visualization: if you picked up the building and turned it upside down, anything that falls out isn't the target. Tables, chairs, and uninstalled equipment are clearly personal property.
What we're after are those installed assets that support your function or process. Using appropriate guidance, the team evaluates whether assets are removable and reusable, even if they're currently installed. It's more complex than it might seem at first glance, which is why working with experts is essential.
Timing matters. The ideal time for a cost segregation study is in your building's transaction year, whether you just completed construction or purchased the property. This gives you the maximum time value of money benefit to recover any fees associated with the study.
That said, you're not out of luck if you missed that window. You can conduct a study on properties placed in service in previous years, technically going all the way back to 1987. However, the further back you go, the less advantageous it becomes due to lost time value.
We recently worked with a mutual client here in Southwest Virginia who had been renting their space for multiple years before purchasing it from the previous owner. This purchase triggered the opportunity for a cost segregation study, and combined with an R&D study, they were able to save some real dollars. It's a perfect example of how important it is to evaluate these opportunities at key transaction points.
Cost segregation is truly a cash flow tool. If you're making income and could use deductions, John calls it an "income problem" in air quotes. When your tax liability is high, accelerating depreciation deductions drives down that liability, keeping more money in your pocket.
For manufacturing businesses investing in facilities, whether through new construction or acquisition, cost segregation studies represent a significant opportunity. In my next blog, I'll dive deeper into the actual process and what you can expect when working with a cost segregation specialist.