Can you benefit from a Cost Segregation Study?
Submitted by S. Leonhard
If you have recently acquired or constructed real estate, or have made a significant renovation or remodeling investment, you have an opportunity to benefit from a Cost Segregation Study. In addition to reducing your taxable income for a number of years this exercise can substantially increase your cash flow.
Cost segregation is a proven tax planning strategy that allows the owner of commercial real estate to accelerate depreciation deductions and defer tax payments. You can use a Cost Segregation Study when purchasing or constructing a building, and you can use this type of analysis for a building that was acquired several years ago.
Under the current Modified Accelerated Cost Recovery System (MACRS) depreciation rules, newly acquired, constructed or substantially remodeled buildings must be depreciated over a period as long as 39 years. However, MACRS allows for the allocation of a portion of the property into asset categories that can be depreciated over a shorter period of time such as 5, 7 and 15 years.
The purpose of a Cost Segregation Study is to identify and maximize the allocation of the building cost that qualifies for the shorter depreciation categories. This allows for greater depreciation during the early years of the asset life which lowers the taxable income and the resulting tax liability. Lowering the tax liability increases the cash flow to the owner of the property. Keep in mind that the study does not eliminate the tax but defers the tax to later years and therefore generates savings immediately. As an added benefit the study may also help to reduce your real estate taxes.
The IRS requires specialized engineering firms to perform a Cost Segregation Study using a detailed engineering approach that clearly identifies the allocation of cost to the various depreciation categories. The cost for this analysis has become very affordable and is often completed in tandem with your accounting firm and a qualified engineering firm. The preparation of a Cost Segregation Study also provides you with an objective allocation of costs that will withstand IRS scrutiny. Complete IRS support is generally included as part of the study.
To immediately realize the maximum tax savings from accurately classifying your building’s asset categories, the best time to complete a cost segregation study is the year in which a building is purchased, constructed or renovated. However, even if it is much later the IRS allows you to catch-up on any missed depreciation in the current year without having to file an amended return.
If you feel you could benefit from a cost segregation study you may want to contact your CPA firm to see if they have an arrangement with a local engineering firm that can provide the necessary study using the required detailed engineering report. The savings achieved can exceed the cost of the study many times over.