Many property owners and real estate investors are familiar with the term “cost segregation” but may not know whether they can take advantage of accelerated depreciation for valuable cost savings. In other words, your real estate may be eligible for a cost segregation study and you may not even know it. If so, you could be leaving money on the table.
What is a Cost Segregation Study?
Cost segregation refers to the process of identifying and classifying subcomponents or units of property. Regarding real estate, this includes identifying tangible property, land improvement and the building and its structural components. The objective of the study is to identify items for faster depreciation as personal property (five-year or seven-year) or land improvements (15-year) as opposed to real property which depreciates over 27.5 years for residential and 39 years for commercial.
A qualified engineer will use blueprints and cost reports to determine whether property can be reclassified for tax benefits. You might be surprised to learn, for example, that decorative light fixtures might qualify for a short five-year life. Without a cost segregation study, you very well may be depreciating those light fixtures over 27.5 or 39 years, when you could instead benefit from additional cash flow that you could reinvest in your business.
When you consider that 20-30% of a building will typically qualify for a shorter class life, it’s easy to understand how accelerated depreciation can produce a very large tax deduction in the year the cost segregation is performed. The ability to deduct 20-30% of the cost of the building in the study year is the primary benefit of the cost segregation study.
For example, a non-residential building purchased in the current year for $1.2M with no cost segregation study resulted in a $13,889 first-year tax benefit. Had a cost segregation study been performed, it would have determined the correct allocation of the building components, with a first-year benefit of $56,528.00. As you can see, the study increased the reduction in taxable income by $42,639 in the first year alone.
Was your building placed in service in prior years? If so, it may well be possible to qualify for even greater deductions. A cost segregation study applies the correct recovery period to the building from the date it was placed in service. This catch-up in depreciation is realized in the current year.
Following the example above, an even greater first-year benefit is found via cost segregation, with the same building placed in service 1.5 years prior and a cost segregation study conducted during the current year. After the study, a first-year benefit of $151,444 is identified. However, a 481(a) adjustment of 39-year property is required to properly calculate the catch-up in depreciation. With an adjustment of $13,836, the new first-year benefit is identified as $111,914. A benefit like this often defers tax for four or more years.
Tax Benefits Associated With Cost Segregation Studies
Now that you understand the purpose and method of a cost segregation study, how does cost segregation directly impact your bottom line? By deferring tax liabilities, investors and building owners can use cost segregation to:
- Leverage your real estate investment to scale their business
- Pursue other opportunities that offer significant returns
- Invest in new equipment, warehouse management software, and add staff
- Implement new product concepts to production and launch
- Invest in other areas of the business for business growth the options are endless
An engineering-based cost segregation study, performed by specialized experts, will ensure that all allowable property be approved by the IRS for accelerated depreciation. Even if you are depreciating in an accelerated manner, you may still be missing out on benefits. The staff of ETS consists of skilled professionals who can properly identify all opportunities available to you.
The engineering and tax professionals on the cost segregation team at Engineered Tax Services have helped real estate owners and investors significantly increase their cash flow by identifying and reclassifying assets of their building for faster depreciation. Request a free benefit analysis to identify an estimated benefit and ensure a cost segregation study makes sense for your property.
To learn more about cost segregation studies for real estate owners and investors, call Engineered Tax Services at (800) 236-6519 or visit our cost segregation page for more information.