Cost Segregation Studies
Cost segregation studies have the potential to save thousands for commercial real estate developers and owners. These studies are used to maximize tax deductions from the acquisition or construction of a building by shortening the depreciation life of assets. Every $100,000 in reclassified assets can create approximately $16,000 in net-present-value savings.
Cost segregation studies do more than merely accelerate depreciation and reduce taxable income. Reclassifying assets in different categories creates additional cash flow for the business owner by having a lower potential tax liability. This allows the owner to consider other uses for this new-found cash flow, such as purchasing more assets to increase efficiencies or making additional investments to allow expansion of the business.
Cost segregation isn’t only relevant when purchasing real estate, it can also be conducted years after disposing of real estate as long as the tax year of disposition still falls within the statute of limitations. Furthermore, these studies help justify the need for disposing of separating building components if a specific portion becomes obsolete or worthless.
There are two components of separating real estate costs: tangible personal property and real property.
Tangible Personal Property
Tangible personal property generally includes equipment, furniture, fixtures and carpeting that can be moved with certain ease, without damage or compromising the asset’s integrity. These personal property items can be depreciated over 5, 7, or 15 years of useful life, thereby accelerating the depreciation deductions and potentially reducing taxable income for the business owner. This asset classification also could have further tax deductions through the use of Section 179 expense or bonus depreciation.
Real property is the second fundamental component of cost segregation, which consists of permanent assets that are structural and affixed to the real estate and unable to be relocated. Real property is depreciated over the use life of 39 years for standard commercial real estate.
How Cost Segregation Studies Work
A brief up front analysis should be done to determine the potential cost and benefit of a cost segregation study. This typically involves discussions between the engineering specialist, CPA, and business owner. If the initial assessment proves beneficial, an engineering report is created, and the engineering specialist and CPA determine how to reclassify into the proper asset classes. Once the due diligence is completed, a strategy for implementing the study is put in place. The asset classifications are developed with the proper depreciation methods for both tangible personal and real property calculated. The potential increase in depreciation deductions should significantly reduce the business owner’s tax expenditures.
To fully understand how these laws may be relevant to your bottom line, please contact Larry Wood, CPA/CFP and Managing Partner at DZH Phillips, one of the most competent and prestigious accounting firms on the west coast. Larry brings a wide breadth of experience to the table, with a particular emphasis on real estate and income tax planning. Click here to contact him to discuss your specific needs, or email him directly at LWood@Dzhphillips.com.