What Is Cost Segregation?
Cost segregation is a cash flow improvement strategy that accelerates depreciation deductions to reduce or eliminate Federal and State income taxes. Cost segregation has become an increasingly valuable but not commonly understood tax strategy that should be considered by virtually every taxpayer who owns, constructs, renovates or acquires real estate.
Cost segregation studies are an engineering-based approach to identifying assets within a building that can be reclassified into a much shorter depreciation class than the building itself. Real estate properties, and everything in them except movable furniture and equipment, are generally depreciated using a straight-line method over 39 years (27.5 years for residential rental property). The cost segregation study maximizes the inherent tax benefit of real estate by identifying, quantifying and segregating the personal property and land improvement components of the property, resulting in depreciable lives of 5, 7, and 15 years using accelerated depreciation.
The tax benefits can be applied to almost all commercial property types including:
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- Assisted living facilities
- Auto dealerships
- Office buildings
- Hi-tech facilities
- Manufacturing facilities
- Medical buildings
- Shopping centers
Who can benefit from Cost Segregation?
A study is typically economically feasible for any commercial property with a building cost basis greater than $1,000,000 (excluding land) and should be considered by any taxpayer who:
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- Recently acquired property,
- Recently started or completed a construction project,
- Acquired property within the last 15 years that did not have a full cost segregation study performed,
- Received property from an estate that will have the basis stepped up, or
- Purchased a partnership share.
How much can be saved?
Tax benefits vary by property type. Greater benefits can generally be derived from properties with a higher percentage of the following:
On average, the taxpayer’s cash flow (present value) is increased by 20 cents for each dollar that is reclassified. For example: A property with a cost of $5,000,000 should expect cash flow benefits of at least $200,000 if 20 percent of the costs are reclassified. Typically between 15 and 40 percent of a building's overall costs can be reclassified to a shorter recovery period.
- Special use equipment
- Interior finishes
- Land improvements
- Other non-structural components
Click here for estimated benefits for various property types.
The actual amount of savings depends on the type of property and its specific construction components. You can receive a free estimate of benefits for a specific property by filling out the Proposal Request Form.
How is the study performed?
The process is detailed and in-depth, but non-intrusive. The cost segregation specialist uses an engineering-based approach as specified by the IRS. Their job is to examine architectural and engineering drawings for potential asset reclassification. A physical inspection will also be performed. Cost data, including the contractor's application for payments, change orders, owner incurred cost and disbursements are examined. Direct labor, material components and indirect costs are allocated based on an analysis of drawings and specifications.
An existing property without the above documentation, such as an acquisition, requires a different approach. The specialist must become familiar with the purpose and major functions of the property. Then a full cost estimating analysis of the property is conducted, including inspection, photographs and measurements. This allows the specialist to reconstruct the property on paper, including all components. Values are then attributed to the components using standard construction cost estimating manuals such as RSMeans Building Construction Cost Data and Marshall Valuation Service.
Who can perform a cost segregation study?
The IRS requires that a study be "performed by 'qualified' individuals or firms, such as those employing … personnel competent in design, construction, auditing, and estimating procedures relating to building construction." Our team approach will result in a study that maximizes the tax benefits of the study, while conforming to IRS regulations and appraisal guidelines of The Appraisal Foundation (USPAP) and by the American Society of Appraisers (ASA).
All work is performed in-house by our specially trained cost segregation engineers, each with significant experience in performing these highly specialized analyses. We are well versed in the IRS requirements and use this knowledge as the framework for our projects.
How do I get started?
CRS provides proposals at no cost, so a building owner may objectively evaluate potential benefits. Do not assume that your CPA has performed a cost segregation study in conjunction with the filing of your annual tax returns or that it's too late to file one for your existing building.
Ask your CPA if a full cost segregation analysis that follows IRS guidelines has been performed on your property. If not, discuss getting a cost segregation specialist involved on your team.
Why should you pay any more in Federal and State income taxes than you absolutely have to? Don't delay. Call Jerry Kootman, CPA or Rob Rahner, ASA, CFA at (732) 548-3855 today to find out how much you are entitled to save.