Soft Costs: Depreciable or Not?

by Eric Rader, EIT, Engineering Associate

What soft costs should be included in the depreciable cost basis? This is a very common, and confusing, issue for many property owners. A variety of soft costs can be accrued over the course of constructing a new building, renovating an existing building, or the acquisition of a property. Deciding which costs to include or exclude can easily change the cost basis of a property by hundreds of thousands of dollars!

Hard costs, commonly referred to as “brick and mortar” costs, are the expenses related to the physical construction of a building and improvements. Hard costs are tangible, fixed assets related to a property. Labor and materials are the primary hard costs accrued during a construction project. With few exceptions, all hard costs should be included in the depreciable cost basis.

Soft costs are more intangible costs not directly related to a specific construction task. Soft costs related to the construction of a building or improvements should generally be capitalized and included in the depreciable cost basis in a cost segregation study. These types of costs include professional fees of architects and engineers, contractor fees, general conditions, short term rentals of equipment during construction (portable toilets, trailers, tools, heavy equipment, computers, telephones, etc.), permitting, and builder’s risk insurance.

Some miscellaneous soft costs not directly related to the construction of a building or improvements can also be included in the depreciable cost basis. Real estate taxes are often one of largest of these includable soft costs.

Legal fees paid to acquire a property are also to be included, as are the costs of having an appraisal performed on a property. Other assorted fees associated with the acquisition, rather than the construction, of a property that can be capitalized include filing fees, title insurance, and bank processing fees.

Soft costs associated with the financing of loans in the acquisition or construction of a property should generally NOT be included in the depreciable cost basis of a cost segregation study. For instance, interest paid on a loan used to finance construction or acquisition is not a depreciable cost. Other costs associated with loans that should be amortized rather than capitalized include escrow fees, recording fees, and miscellaneous bank fees.

Below is a typical case study

It is easy to see why determining the soft costs to include in a property’s cost basis is a confusing issue. There are many other considerations, exceptions, and gray areas that complicate this issue. It is just one of many reasons it is important to choose experienced professionals to perform your cost segregation study!

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