As a property owner, cost segregation is one of the best ways for you to uncover potential tax savings and increase your cash flow through the reclassification and faster depreciation of property. Recent changes in the tax code further enhance the value of cost segregation. It is helpful to first understand which properties most benefit from having a cost segregation study.
While not all-inclusive, the following five categories of real estate are likely to reap the benefits of seeking a cost segregations study from a qualified cost segregation expert.
Business and Rental Real Estate
Properties can benefit from a cost segregation study as long as they qualify for depreciation deductions. This includes most buildings and structures that are either used in a business or held for rental income, but it does not include raw land. Personal residences also do not qualify.
Newly Acquired or Constructed Property
Newly acquired or constructed property can also benefit from a cost segregation study. Not only does the cost segregation study identify the class lives for depreciation, it also identifies the units of property that qualify for Section 179 expensing for newly acquired or constructed property.
Section 179 expensing is different than depreciation as it allows for an immediate deduction for certain equipment in the year it is acquired. Section 179 expensing is taken in lieu of depreciation. Recent changes in the law added some real estate components to the list of property that qualifies under Section 179, such as roofs and HVAC units. A cost segregation study can help you realize these expenses currently rather than depreciating them over their class lives.
Similarly, the cost segregation study will help identify the property that qualifies for bonus depreciation. Given the recent changes in the law, bonus depreciation can provide a 100 percent deduction for the cost of qualifying property for the first year the property is placed in service. The new law also says that used property – not just new property – can qualify for bonus depreciation. This means that you can take 100 percent bonus depreciation when you purchase real estate.
Recently Sold Real Estate
A property may still be a good candidate for a cost segregation study even if you recently sold it—as long as you sold the property and have not yet filed the tax return to report the sale, there can be an opportunity to do a cost segregation study to begin maximizing tax deductions in the year of the sale.
The benefit of post-sale cost segregation studies relates to the tax rate savings. Depreciation deductions, including a large final year catch-up depreciation deduction, will generally offset income taxed at ordinary tax rates. This tax deduction reduces the tax basis in the property and, as such, increases the gain on the sale of the property. Assuming the property was held for more than a year, however, the increased gain will be taxed at the much lower capital gains tax rates. This is where the tax benefit comes in—the reduction of income taxed at higher ordinary tax rates versus the increase in gains subject to lower capital gains tax rates.
Tenants can also benefit from cost segregation studies given that tenant improvements may also qualify for depreciation. Even small tenant improvements can produce significant tax savings given that they may qualify for 100% bonus depreciation under the new tax rules.
There is a misconception about real estate that does not have a lot of personal property associated with it. Industrial warehouses provide an example. It is often thought that there is no benefit to doing a cost segregation study for these properties, but this isn’t true.
There can still be a significant benefit because these properties generally have a significant amount of land improvements. Land improvements generally have a much shorter class life than the building or structure. They may also have certain portions of electrical, mechanical, and plumbing that can also qualify for shorter class lives. A cost segregation study can help you realize these tax benefits sooner rather than later.
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.