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Cost Segregation Studies, Green Energy Tax Credits, and Enterprise Zones

Luis “Lou” Guerrero has always been good with numbers and working through problems logically. So pursuing a career in accounting was a natural fit, because it gave him the opportunity to help businesses intelligently navigate their finances. A certified public accountant, he worked with the small business audit group and tax department of Touche Ross & Co. (now Deloitte & Touche) for eight years, and ran his own accounting practice for a stint. In 1995, he joined the Pasadena-based accounting firm now known as Krost, Baumgarten, Kniss & Guerrero. He helped launch a division of the company, KBKG, Inc., in 1999 to specialize in cost segregation studies. KBKG now also helps businesses obtain green building and Enterprise Zone tax credits, among other services. KBKG has an office in Woodland Hills. Guerrero said many business owners don’t know about the financial benefits of doing a cost segregation study and how to go about obtaining other tax credits. As a result, they’re missing out on thousands, if not millions, of dollars in increased cash flow. Question: What is a cost segregation study? Answer: Cost segregation is a tax savings tool that allows companies and individuals who have constructed, purchased, expanded, or remodeled any kind of real estate to increase cash flow by accelerating depreciation deductions and deferring federal and state income taxes. In general, it’s easy to identify furniture, fixtures, and equipment that are depreciated over five or seven years for tax purposes. However, the studies go far beyond that by dissecting construction costs that are usually depreciated over 27-and-a-half or 39 years. The goal is to identify all construction related costs that can be depreciated over five, seven, and 15 years. For example, 30-90 percent of the total electrical costs in most buildings can qualify as personal property that’s eligible to be depreciated over five or seven years. Reducing tax lives results in accelerated depreciation deductions, reduced tax liability, and increased cash flow. Conducting a quality study involves a review of cost detail and blueprints, site inspection, photo documentation, cost estimation, and preparation of a report. KBKG works with a team of engineers and tax experts. Q: What’s the financial benefit of doing this type of study? A: The depreciation for a property with a cost segregation study allows for a significant increase in deductions within the first five years. Assuming a combined tax rate of 41 percent and a return on investment factor of eight percent, every $100,000 of costs shifted from 39-year property to five-year property creates a present value tax benefit of approximately $22,000. Every $100,000 of costs shifted from 39-year property to 15-year property creates a present value tax benefit of approximately $12,000. Q: What types of clients/properties are best suited for cost seg studies? A: Anybody who has paid taxes over the past five years and acquired a building in the past 15 years. And any structure used for business or as rental property is eligible. But cost segregation studies are not as relevant for buildings somebody has owned for a long time. The longer you’ve owned a building, the lower the present value benefit. If you’re planning on holding the property for only a few years, it probably doesn’t make sense. In general, clients plan on holding the property for three, four, five years or more. And every time a property exchanges, a study can be done again. It’s a present value play. You’re changing the timing to get tax deductions now versus later on. Q: Why are you focusing on cost seg? A: The original accounting firm, now known as Krost, Baumgarten, Kniss and Guerrero, was founded in 1939 in Pasadena. Over the years it specialized in restaurants. One restaurant in particular had 20 locations. After doing cost seg studies on those properties, the client was able to secure a $2 million refund. Up until the late 1990s, there were hundreds of court cases about cost segregation and the IRS was fighting the concept. But around 1997, a landmark case (Hospital Corporation of America vs. Commissioner) provided the legal support to use cost segregation studies for computing depreciation. That’s when we jumped in. We created two separate companies, KBKG, Inc. being the one that specializes in cost segregation. And we realized the best way to sell the concept was to do it directly to other CPAs. So we started by offering a lot of continuing education to CPAs. In turn, they would often hire us or their clients would hire us to do the studies. Q: KBKG also specializes in helping businesses secure green building and Enterprise Zone tax credits. Can you tell me more about these? A: The most common green tax credit is the residential 45L tax credit, which is applicable to residential developers such as those building single family homes, apartments or condominiums. All apartment and residential condo developments completed on or after August 8, 2005 are worth assessing. They can receive up to $2,000 per unit for things like reductions in electricity and gas usage, increased insulation and using energy efficient appliances. Q: How do business owners access the credit? A: A study needs to be done to look at the energy efficiency of the property. We conduct an engineering-based study to determine how many units qualify for the tax credit. That study is then given to the client’s CPA who applies for the credit. Most residential construction in California completed after Aug. 8, 2005 qualifies because we have such strict building standards. Another green tax credit is Section 48. Business owners can get a credit worth up to 30 percent of the amount they spent on equipment such as fuel cell properties, small wind energy, and equipment that heats or cools a structure with solar energy. And since many businesses are not paying as much taxes right now, because of the economy, the federal government is offering grants in lieu of the credits for the same amount of money. Q: What about Enterprise Zone credits? A: This is another one of those often overlooked credits that can be very useful to businesses paying California taxes. The Enterprise Zone credit approves up to $37,440 in state credit over a five-year period for each eligible employee. And there are a lot of opportunities in the San Fernando Valley for getting Enterprise Zone credits.

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