Coming up with the estimated value of every component of your client’s property and dropping them into different depreciation periods is not the end of your cost segregation study. You will need to update those numbers in what is called ‘reconciliation’.
In this article, we’ll explain what reconciliation means for cost segregation studies in particular, how it works, and how you can complete it in less time.
What is reconciling the tax basis in a cost segregation study?
When doing a cost segregation study, you calculate the value of all components within your property using RS means estimates, then drop each of those components into different buckets for depreciation periods. Those buckets will be depreciation periods of 5, 7, 15, 27, or 39.5 years, depending on several factors.
However, the value of those components that you get from RS means is not the final value you will use in your cost segregation study. You will need to reconcile those values up to the depreciable tax basis. So, when referring to ‘reconciliation’ in a cost segregation study, we mean calculating the difference between the RSMeans cost estimates for your property’s components and the true depreciable tax basis.
What is the true depreciable tax basis?
In a cost segregation study, the depreciable tax basis of your property is the improvement value divided by the total value. For example, if there are $14M in improvements on a $21 million dollar property, then the depreciable tax basis would be 0.67.
To come up with the improvement value and the total value, you can use tax-assessed records from online tools like ReGrid, or you can get an appraisal done for the most accurate cost. Reasonable estimates are okay for cost segregation studies, which is why it’s sometimes okay to use tools like ReGrid, but an appraisal is foolproof.
When and why you need to reconcile to the tax basis
Reconciling to the tax basis is necessary for a Purchase Price Allocation (aka “PPA study”) type study (as opposed to new construction studies). In cost segregation, you’re re-estimating the total cost to rebuild the property in its current state using acceptable assumptions and a reliable cost database (the gold standard is RS Means). Because it is re-estimating how much it would cost to rebuild the property, the re-estimated total is not going to be equal to the tax basis of the property.
There are multiple reasons that the re-estimation won’t be equal to the tax basis of the property:
- Estimating is just estimating, and not intended to be exact costs.
- Even if we could get exact estimations, that doesn’t account for market forces that can cause purchase prices to fluctuate above or below the re-estimated amount.
How do you perform reconciliation in a cost segregation study?
Reconciliation is typically performed at the end of your cost segregation study after you’ve collected all of the costs of the various components of your property and distributed them into different categories for accelerated (or non-accelerated) depreciation. At this point, you have the cost estimates done using RSMeans estimates (if you’re using SegStream) and you should have the true depreciable tax basis.
If your total costs from RSMeans is $5.5M and the true depreciable tax basis of your property is $8M, then you would calculate $8M / $5.5M, which is about 1.45. That 1.45 number is the factor that you will then apply to all costs of the property components you identified. Basically, you break out every cost that added up to the $5.5M, then multiply them individually by 1.45. Then, your final number will equal $8M, which is the same as your true depreciable tax basis.
In this example, all of the cost estimates grow by 45% to match the true depreciable tax basis of $8M.
How do you perform reconciliation in SegStream Pro?
In SegStream Pro, reconciliation is as easy as pushing a button. Since all the numbers are already there, you don’t have to do any manual calculations to complete this step. In cost seg, this process is called “the squeeze”. So, in SegStream Pro, you simply hit the “squeeze” button and everything is squeezed up to the depreciable tax basis. However, the percentages of your components within the different depreciation period buckets (5,7,15, 27.5, or 39 years) will grow in proportion to the growth factor that we calculated above.
So rather than doing these calculations in a spreadsheet and potentially making a mistake, you can do them with the click of a button after you’ve entered the information you need for your study. This is a much faster and more secure way to do this calculation, and you can be sure the estimates are reasonable since SegStream is connected to the RS means database.
This is one of the many ways that SegStream makes cost segregation studies faster and easier. In turn, this gives you the ability to take on more clients since you don’t spend so much time manually doing calculations like these.