Cost segregation studies are one of the most valuable tax strategies available to real estate investors and commercial property owners today.
See also Real Estate
Rarely are these groups afforded the opportunity to realize the type of tax savings which can be generated from a cost segregation study. The good news is that many taxpayer who owns, constructs, renovates, or acquires real estate property in any industry – whether commercial or rental – can benefit from a cost segregation study. In general, buildings worth more than $1 million or improvements that cost more than $500,000 are the best candidates. To help clients, prospects and other understand the benefit of a cost segregation study, Hanson & Co., has provided a brief summary below.
About Cost Segregation Studies
The purpose of a cost segregation study is to identify assets and costs related to a real estate purchase, reconstruction or leasehold improvement and reclassify those assets for federal tax purposes. Certain costs previously subject to a 39-year depreciable life can instead be reclassified with a five, seven, or 15-year rate of depreciation using accelerated methods. By accelerating depreciation, property owners can lower their current tax liability and realize a significant increase in cash flow.
A cost segregation study can be performed at the time of acquisition or construction and implemented on the first tax return for the property. The IRS also allows taxpayers to perform a cost segregation study on a building placed in service during a prior year and “catch up” the additional depreciation amount without an amended tax return.
The IRS requires that cost segregation studies be “engineering-based.” This means that the must study examine a wide range of building components, such as electrical installations, plumbing, mechanical components, and finishes. It may also involve a physical inspection of the property, analysis of architectural and engineering drawings, and review of cost data, including the contractor’s application of payments, material components, change orders, owner-incurred costs, and indirect disbursements.
By providing more precisely itemized property information, the CPA conducting the study will have all the supporting documentation they need to meet IRS regulations and requirements. This allows the building owner to depreciate a new or existing structure in the shortest amount of time permissible under current tax laws. This can add up to substantial tax savings.
How Much Can You Save?
The distinction between what qualifies as short- and long-life property for depreciation purposes has been continually reshaped during the last 20 years by court cases, private letter rulings, and IRS publications. However, according to the AICPA, “Each $100,000 in assets reclassified from a 39-year recovery period to a five-year recovery period results in approximately $22,000 in net-present-value savings, assuming an 8% discount rate and a 40% marginal tax rate.”
Another source calculates that the present value of a taxpayer’s cash flow is increased by about 20 cents for each dollar reclassified out of a 39-year property. In a typical cost segregation study, between 15% and 45% of a building’s costs can be reclassified to shorter-life assets, depending on the type of facility. For a $1 million project, this can equal between $30,000 and $90,000 in increased cash flow – plenty for another down payment or investment in another market with good return rates.
If you have recently purchased commercial property, are about to make a purchase, or have made leasehold improvements then you may qualify to conduct a cost segregation study. Since the tax saving benefit of this approach is quite often very compelling, it’s essential to determine if you quality. For more information on cost segregation studies, Hanson & Co. wants to help. For additional information please contact us at (303) 388-1010 or click here to contact us. We look forward to speaking with you soon!