Let’s pretend that it is tax season – depending on when you’re reading this, it might be. As April 15th approaches, you’re desperately searching through your finances, looking for deductions that can reduce your tax liability. Now, you probably think that you looked everywhere and explored every option. However, there’s one you might’ve missed: cost segregation.
A cost segregation study can be a powerful way to maximize depreciation deductions and minimize the tax burden for commercial property owners who acquire or develop real estate. A Cost Segregation study involves classifying property components that can be identified as personal property in order to lower your tax bill. Sound simple enough? Well, there’s a little bit more to it. What we’re going to do today is walk you through the cost segregation process while listing off the factors that would make you eligible.
Shorter Depreciation = Lower Taxes
As you may know, any property that you or your business owns is slowly depreciating in value over time. With this depreciation comes another expense – something that can be written off as a tax deduction. However, because depreciation of the property occurs over the course of 30 to 40 years, the expense is fairly low. This is where cost segregation comes in.
A cost segregation study is a federal income tax tool that increases your near-term cash flow by deferring taxes.
With a cost segregation analysis, you could be able to write off up to 30-35% of your building’s original purchase price in the first year.
Because depreciation occurs when a purchased building ages, it loses value over time. Actually, your building is not only one piece of property, but comprised of subcomponents (such as lighting fixtures, heating and air conditioning systems, and other components) that deteriorate over time.
But unlike the whole building, which is seen as having either 30 or 40 year lifespan, subcomponents are granted a 5 or 15 year lifespan, making the depreciation deduction larger, especially in the first several years. Consequently, whether your property is residential or commercial, you can write off that cost either in a 30 or 40 year timeframe.
What cost segregation does is speed up the depreciation process by identifying assets that would typically belong to the property as personal assets themselves, with much shorter lengths of depreciation. For example, assets like carpeting and wall covering have a depreciation length of five to ten years compared to 30. This allows you to write off larger depreciation expenses to lower your tax liability.
How Is This Done?
Now that you know what cost segregation is, how do you go about it? Well, it’s a study like I said. That means a cost segregation specialist will come in to analyze various aspects of your property including plumbing, electrical, flooring, and walls just to name a few.
They will also assess improvements to the land surrounding your property like sidewalks and landscaping as well. Based on this assessment, the cost segregation specialist will determine which personal property assets can be reclassified for accelerated depreciation. This will increase the depreciation expense, allowing for a larger deduction come tax time.
Here’s how the process typically works:
- Conduct a Feasibility Analysis: a complimentary estimate of the potential benefits and fees to perform a study for the specific buildings. During this step, your accountant should take time to understand the property owner’s tax position and the significant property characteristics to give a reliable estimate of the benefits a study could provide.
- Gather Additional Information: for a building that was purchased by the taxpayer, this can include: For a building that was constructed or remodeled by the taxpayer, this can include an appraisal, a property condition report, an American Land Title Association (ALTA) survey or site map, and the closing purchase documents for a study being done on the acquisition of a property. For a building that was constructed or remodeled by the taxpayer, this can include overall project costs, general contractor costs and change order details, vendor invoices, and construction drawings.
- Analyze the Property: The next step analyzes the property and provided information, which typically includes completing an on-site tour of the property, examining all drawings and other relevant documents, and classifying all cost information and estimates, including the personal property within the buildings and land improvements around the site.
- Complete a Report: The final step is the completion of a full report, which often includes results of the study, methodology, photos of the property, and tax law supporting the asset classifications. This report should be retained as long as you own or occupy the property. It provides support for asset classifications and can be used in case of an audit by tax authorities.
What Are The Benefits?
As previously stated, cost segregation benefits the property owner in the form of a lower tax liability. In addition to this, cost segregation is also great for estate planning. This can create tax benefit opportunities well after you’re no longer around, which makes payments easier for whoever you decide to leave your estate to. The benefits from a cost segregation study will vary based on the depreciable basis of the improvements, property type, and the amount of short-life assets the property has.
Being audited by the IRS? Fortunately, cost segregation documentation leaves a clean paper trail for the IRS, potentially simplifying matters in the future. Last and definitely not least is an increased cash flow. The lower the tax liability, the more money you save, meaning that you can apply it to other aspects of your home or business.
Let the Experts at Nazaire & Co Help!
Every commercial property is unique. If you’re interested in finding out whether a cost segregation study is right for your property, the first step is connecting with an advisor about your options. For additional information on cost segregation, check our cost segregation services page. If you have any questions or would like a cost segregation study conducted, please contact Nazaire & Co.
For everything else, feel free to visit the Nazaire Blog or contact us today!