Cost segregation is a tax strategy that allows real estate owners to accelerate depreciation deductions for certain components of their property. By identifying and reclassifying specific assets within a property, cost segregation empowers owners to accelerate the depreciation of those assets, leading to greater tax savings during the initial years of ownership.
Cost segregation is based on the idea that not all elements of a property possess equal useful lives for tax purposes. While the building itself is typically depreciated over a longer period, usually 27.5 years for residential real estate and 39 years for commercial real estate, specific components like land improvements, personal property, or specialized building systems may have shorter depreciable lives.
By conducting a cost segregation study, property owners can identify and allocate the costs of short-lived assets separately from the cost of the building. This enables owners to accelerate the depreciation of those assets through methods such as bonus depreciation or accelerated depreciation schedules like 5-year, 7-year, or15-year schedules. As a result, property owners can reduce their taxable income and generate higher tax deductions in the initial years of ownership, leading to a significant cash flow benefit.
A cost segregation study is a comprehensive analysis of the components and their associated costs within a property, with the goal of identifying assets that can be reclassified for accelerated depreciation. Below is a general overview of the workings of a cost segregation study:
The cost segregation team will assess the property, including its blueprints, construction documents, and other property records. Additionally, they may conduct on-site visits to visually inspect and document its components. This comprehensive approach assists in identifying and categorizing various elements within the property. These elements encompass not only building structures but also land improvements, personal property, and specialized building systems.
Once the components have been identified, the team will proceed to assign a cost to each of them by relying on available documentation and industry standards. Invoices, construction contracts, receipts, and other records will be utilized to determine the precise costs associated with each asset. After the cost has been allocated, determining the appropriate asset classification foreach component becomes easy. The team will review IRS (Internal Revenue Service) guidelines and regulations to determine the optimal depreciation schedule for each asset, which may involve utilizing accelerated depreciation methods, such as bonus depreciation or shorter recovery periods.
Finally, the professional consolidates all the findings and calculations into a comprehensive cost segregation study report. This report provides a thorough breakdown of reclassified assets, their associated costs, and the recommended depreciation schedules. Furthermore, it includes the essential documentation and supporting evidence for the utilized asset classification and depreciation methods.
A cost segregation study offers several advantages to distinct categories of real estate owners, including commercial property owners, residential rental property owners, developers, investors, and the individuals undertaking leasehold improvements. By enabling them to identify specific assets within their properties that qualify for accelerated depreciation, the study helps generate higher tax deductions and enhance cash flow. Both flippers and passive investors can also reap the benefits.
The following should do cost segregation:
It is important to emphasize that cost segregation studies should be conducted only by qualified professionals. At Investor Friendly CPA®, we have a team of expert professionals who specialize in evaluating properties, reviewing tax documentation, and preparing comprehensive studies that outline the reclassified assets and their corresponding depreciation schedules. We guide you through the entire process and collaborate with the stakeholders to come up with an optimal study to suit your requirements. Our expertise adheres to the guidelines and regulations established by the Internal Revenue Service (IRS),ensuring their validity and providing support in an audit.