Cost Segregation Studies in Low-Income Housing Tax Credit Industry

The Low-Income Housing Tax Credit (LIHTC) program was developed to attract investment in and promote the development of affordable rental housing. As a complement to the LIHTC program, investors may also utilize what is known as a cost segregation study to further their tax benefits.

In general, a cost segregation study is a useful tool to accelerate depreciation on certain real estate assets, including rental real estate. This is done by identifying the individual components that make up the real estate project. These individual components would have a shorter depreciation period than the building itself, which could be 27.5 or 39 years.

Think of a rental project. It is not just a building. That building has windows, wiring, outlets, various kitchen and bath appliances, light fixtures, HVAC, carpeting, etc. All of which would have a much shorter, useful life than the 27.5 or 39 years the building would have. By segregating these components, the investor could recognize increased depreciation deductions which, in turn, could provide for further tax savings.

Cost Segregation Study Considerations

Sponsors and/or developers with affordable housing projects nearing completion will want to communicate with their investors about their intention of ordering a cost segregation study. While doing so, sponsors and developers will want to keep the following in mind throughout the process.

Communication

As with any transaction or business relationship, communication is key when conducting a cost segregation study. Sponsors and developers will want to communicate with investors about the use of a cost segregation study early in the construction process. The last thing any party wants is to discover last minute that a cost segregation study needs to be performed. This could cause significant delays in audit and tax deliverables. Not to mention, this would not allow for adequate time to conduct a quality cost segregation study.

Due Diligence

All parties involved in the development of an affordable housing project should engage with a qualified and experienced cost segregation specialist or firm. Cost segregation studies are complex and require expertise in engineering, tax law, and accounting. A reputable firm or practitioner will employ engineers and tax professionals who are familiar with IRS guidelines and can provide a comprehensive and defensible report.

Review

Individuals should review the results of the cost segregation study because, at the end of the day, the end-user (i.e. the developer, sponsor, and/or investor) is ultimately responsible for the amounts that are reported on their respective tax returns. A quality cost segregation study will provide enough information for the end-user to be able to interpret the results and conclude on the accuracy of the study. Some of this information would include a detailed description of the methodology (or methodologies) used, the documentation used in determining costs and asset categories, calculation of unit costs, organization of assets into groups, and the reconciliation of total allocated costs to total actual costs.

For further insight, the IRS published a “Cost Segregation Audit Technique Guide,” that provides an in-depth overview of conducting a cost segregation study. Sponsors, developers, and/or investors in an LIHTC development can utilize elements of this guide to assist with their due diligence and review of future cost segregation studies.

McKonly & Asbury, LLP is a leader in accounting for affordable housing partnerships. Our team has the specialized knowledge to help you ensure you comply with IRS and tax credit allocating agency reporting requirements. For more information on these services and more be sure to visit our Affordable Housing page, and don’t hesitate to contact us.

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