Here is a strong suggestion to commercial property owners: When you are acquiring or developing a property, consult with your CPA at the start of the process in order to determine if a Cost Segregation Study is appropriate for you. By bringing your architect/ engineering and accounting professionals together early on when acquiring or developing a property you can be confident that an appropriate and cost effective study is conducted.

Advantages of a Cost Segregation Study

The benefit of obtaining a Cost Segregation study is that it can shorten the useful lives of assets under accelerated depreciation methods.  By implementing a Cost Segregation strategy the taxpayer reduces current federal taxable income by taking the maximum deduction permissible under the tax code.   While the advantages can be significant, a Cost Segregation study should only be prepared by an experienced qualified individual who issues a report to support the assumptions used in the classification of assets.     

Calculations and Processes in a Cost Segregation Study

When a commercial property is placed into service, the general method of depreciation would be over 39.5 years utilizing the straight line method.  However, there are other options.

Cost Segregation is a process of taking the building and breaking down the individual components of the building into four categories which are:  (1) personal property, (2) land improvements (3) building and (4) land.  The components that qualify as personal property and land improvements qualify for shorter useful lives under accelerated methods of depreciation.  Tangible personal property generally falls under five and seven year useful life, while land improvements are classified under 15 year property.   

Note; It is important to be able to support the study’s results because the determination of what qualifies as tangible personal property and what are the structural components of the building have been challenged under audit and have led to numerous tax court cases over the years, along with the issuance of private letter rulings and publications from the Internal Revenue Service.

You want to avoid being challenged under audit so you need to consider that the Internal Revenue Service (IRS) has trained its agents and has issued guidance to be utilized in audit situations.  Auditors are trained to ask for a written engineering based cost segregation report prepared by an individual with expertise and experience.  A well designed Cost Segregation report generally includes, but is not limited to. a narrative of the property, a detailed cost analysis of assets qualifying under the four categories listed above, pictures of the property, and a methodology overview for any assumptions used and citing applicable tax law.    

Conclusion: It is Worth the Effort!

Cost Segregation can be one of the most advantageous tax strategies available to property owners. Accelerating depreciation deductions leads to a lowering of taxable income and taxes due.  As a result, the owner increases cash flow into the business and reinvests the savings to continue growing the business.  

Remember to consult with your CPA before undertaking a study while keeping in mind that this is a Federal tax law and as such some states may not allow this strategy to be implemented.