If you’re building, buying, or renovating a manufacturing facility, a cost segregation study (CSS) can help you save taxes and improve cash flow. A CSS identifies assets that can be classified as personal property (depreciable over 5,7, or 15 years) instead of real property (depreciable over 39 years).

You’d be surprised how often manufacturing assets are unnecessarily classified as real property. Manufacturing equipment is usually considered personal property, but did you know that many building costs can also be written off under the more aggressive personal property schedules?

Suppose a manufacturer builds a new plant and is required to reinforce a portion of the floor to accommodate the weight of certain manufacturing equipment. In most cases, the manufacturer can write off the labor, material, and overhead costs associated with these modifications over the same cost recovery period as the equipment. The same principle applies to special ventilation or electrical wiring requirements unique to the manufacturer’s operations.

A CSS probably won’t generate many benefits for a simple warehouse, but for a manufacturing or processing plant with special construction requirements, the tax savings can be significant. One study estimated 25% to 70% of the cost of a heavy manufacturing plant could be reclassified and written off over periods of less than 39 years. Consider this example:

A manufacturer builds a new facility for $2 million and places it in service June 1, 1999. If the entire cost is depreciated over 39 years, depreciation deductions for the first two years total $79,100. If, however, a CSS indicates that $200,000 is properly allocated to 5-year property and $800,000 to 7-year property, dentives available to manufacturers in certain locations.

Plan Early

It’s possible to perform a CSS for an existing facility. But doing the analysis before and during the construction process offers several advantages:

• It’s easier to identify and document personal property costs by working with the architect or engineer in the planning stages. Once the building is complete, many reclassification opportunities are more difficult to detect and assets are more difficult to value.
• It’s more difficult for the IRS to challenge cost allocations if the builder segregates these costs before or during the construction.
• A post-construction analysis may make it necessary to change depreciation methods for certain assets, which requires IRS approval.