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When we think of buying new properties or doing renovations, the first thing we have to consider is cost.  Now is the time to think in contrast.  Why?  Because these new buildings will provide property owners the ability to reduce the current taxable income. How?  It’s through a cost segregation study.

What is a cost segregation study?

The process of cost segregation is a strategic planning tool that involves identifying the personal property assets and reclassifies them to shorten the depreciation time.  When considering a cost segregation study, it is essential that you choose licensed and experienced professionals that are well-versed in federal tax law.  This assistance can be from your local accountant if they have experience with cost segregation study processes.  Also, having a team of professionals like an attorney and an engineer working with your accountant will help ensure that the components of the study are accurately classified and in compliance with IRS guidelines.  Each step of the way, these professionals should keep you informed of their processes giving you peace of mind.

What is the advantage of a cost segregation study?

The primary advantage of doing a cost segregation study is it provides an opportunity for commercial property owners to reduce federal and state income tax.  Other advantages include easier future depreciation recapturing, tax relief, and financial benefits.  How does this work?  Let us take a closer look on the processes and how it is calculated.

Process and Calculation for Cost Segregation Study

If a commercial property is to be placed into service, the normal depreciation time would be 39 years if the straight-line method is done.  On the other hand, if a cost segregation study is done, the individual components of the building would be broken down and will then be categorized into the following:

  • personal property
  • land improvement
  • building
  • land

Those components that will be tagged as personal property and land improvement can qualify for shorter lives under accelerated depreciation.  When the personal property is deemed tangible, its useful life is up to 5-7 years.  The term “useful life” refers to how long it will take the asset to completely fall apart.  Land improvements are classified under the 15-year property.

An important reminder at this point is that the cost segregation study should be supported strongly and accordingly with documentation.  Due diligence is vital.  If the IRS is not able to determine what components are tangible personal property and what components are considered a structural part of the building, that can result in tax court.

The IRS (Internal Revenue Service) is responsible for collecting taxes and administering the revenue code. The IRS has agents that are trained specifically for audits of cost segregation studies.  A good auditor will ask for your written engineering-based cost segregation report.  This report should include a narrative of the property, a specified cost analysis of the assets, pictures, and a methodology brief for assumptions used.

There is a big tax benefit if you are applying a cost segregation study to your acquired property.  If you are considering a cost segregation study, you should consult with your CPA first before applying.  In conclusion, a cost segregation study can be a powerful tool for real estate investors.  To ensure you gain the maximum potential of this tool, it is best to consult with a CPA or cost segregation specialist for your particular property.