By: Donald K. Archer

One of the stickier problems we have encountered in reconciling the costs for a cost segregation study is what are and how do we handle the indirect costs of a new construction project. Historically, indirect costs have been lumped into a single cost category and depreciated as 39-year real property; however, this practice produces skewed results since a portion of these costs should be subjected to accelerated depreciation.

Unlike direct costs where unit costs can be applied to specific work activities, indirect costs have no such applications. Rather, they are calculated on the basis of percentages or rental rates and summed over the length of the project. Among the indirect costs commonly found on construction projects are architectural/engineering fees, material testing costs, a contractor’s general conditions that may include supervisory salaries, project insurance, bonds, tools, portable toilet rentals, trash collection, office trailers, telephones, computers, etc. and capitalized interest and taxes. Contractor overhead and profit are also project costs that the owner must capitalize.

Collecting and allocating indirect costs is typically a matter of calculating the ratio of indirect to direct costs and applying the result to each component given in the depreciation schedule. This method allows a fair and consistent distribution of the indirect cost; however, other methods have been attempted with limited success. Applying dedicated indirect costs to specific direct cost items has been used as an allocation method, but it has resulted in obtuse totals in some cases. On occasion it may be more accurate to apply a known indirect cost to a specific direct cost component. Such an example may be the engineering design cost for a steel mezzanine structure. Since the design was applied to a single component, it would appear that the cost is more representative.

Inclusion of corporate overhead and profit is perhaps the most misunderstood concept in construction cost analysis. General conditions, architect/engineering fees, permits, rentals, etc. are project indirect costs whereas corporate offices, executive and staff salaries, equipment, etc. are corporate overhead (indirect) costs. The corporate overhead is applied to all project costs as a means of recovering the home office expenses and the resulting total is multiplied by the desired profit margin. Even though the overhead and profit are revenues for the contractor, they are costs to the owner and need to be included in the indirect cost total for the project.

Oftentimes owners acquire existing facilities and accrue settlement charges that are considered for the most part to be indirect costs. These costs generally include appraisals, filing fees, legal fees, title insurance and bank processing fees. Other expenses such as recording fees, escrow fees and miscellaneous bank fees are amortized as fees associated with the loan and not included in the capitalized total of the project.

Even though some of the costs incurred by the general contractor are expensed they are considered capitalized project costs. The IRS has published a general list of indirect costs that are required to be capitalized and those that are not. Some of the more common capitalized indirect costs that can be incurred include indirect labor and material, purchasing costs, handling costs, storage, rent, taxes, insurance, utilities, repairs and maintenance costs, engineering and design fees, tools and equipment, bidding costs, permits, licensing and franchise costs, and interest. Indirect costs that are not required to be capitalized are selling and distribution costs, research and experimental expenditures, on site storage costs, and deductable service costs. The complete list may be found on the IRS website.

Mr. Archer is a Civil Engineer with a Masters degree in Business Administration and a Masters Degree in Engineering Management. He is an Adjunct Professor of Engineering Management at the University of Louisville and is the President of his own engineering company, Lindon Engineering Services, Inc.

Cost Segregation Treatment of Indirect Costs