Introduced by the Tax Reform Act of 1986, cost segregation is an often-overlooked tax strategy that can dramatically help business owners who have constructed, purchased, updated, or expanded real estate investments. This technique speeds up depreciation deductions and helps defer overall state and federal income taxes.
A shorter cost segregation schedule allows taxpayers to claim construction costs on a much shorter timeline. Schedules as low as 15, seven, or five years are available, versus the standard 39 years for nonresidential buildings.
Conducting an in-depth cost segregation analysis is a perfectly legal way to dramatically lower your overall tax bill, leading to significant savings and improved cash flow.
What is cost segregation?
A cost segregation study could help save you thousands of dollars. It allows you to allocate all property-related costs into the appropriate property classes. This helps shorten the depreciation recovery period and can be applied to commercial structures that have been recently built, bought, remodeled, or upgraded.
Cost segregation also applies to buildings that have been in use for many years, and even to some buildings that have already been sold. Any building used for business or purchased by business owners after 1986 may be eligible for cost segregation.
Let’s take a closer look at the advantages and disadvantages of cost segregation:
What are the pros of cost segregation?
Here are four key pros of cost segregation:
1. It comes with a shorter depreciation schedule.
Depreciation schedules typically allow for real estate depreciation over a 27.5- or 39-year period. Accelerated depreciation deductions allow you to depreciate certain assets or elements on a shorter schedule, in 15, seven, or five years. This method of segregating eligible real estate costs can result in substantial savings for commercial property owners.
2. There is a reduction in local realty-transfer tax.
Cost segregation may lower overall local realty-transfer taxes, because local governments often levy these fees based on the current fair market value of a structure. Because a cost segregation analysis reduces a building’s value, it also reduces its applicable transfer tax.
3. Cost segregation isn’t just for property owners.
Anyone leasing a structure who pays upkeep costs related to improving their business can reallocate those costs to accelerate depreciation expenses for upgrades or ongoing maintenance. These real estate costs are related to personal property assets, and can include land improvements, indirect construction costs, and even a building’s non-structural elements. Indirect construction costs can include architectural fees, trash collection, building appraisals, and construction management.
4. Cash flow often increases.
The goal of analyzing expenses related to property renovations, construction, purchasing, and improvements is to minimize taxable income. This leads to lower local, state, and federal taxes, and more cash flow for your business.
What are the cons of cost segregation?
Here are three key cons of cost segregation:
1. Costs aren’t always straightforward.
A building’s costs in cost segregation depend on the building type, property size, and other factors. Segregating costs and expenses is ideal for buildings that are valued at $500,000 or more, but may not be worth it for properties of lesser value.
2. Cost segregation won’t be applicable to every property.
Is it worth conducting a cost segregation study on your property? Well, it depends. That’s why it’s best to work with knowledgeable and experienced tax professionals who can help you decide if you should explore the gains of cost segregation on your residential rental property or commercial real estate.
3. Cost segregation can be expensive.
Like most things in life, you get what you pay for. A quality cost segregation study can be expensive, ranging from $10,000 to $25,000. The overall cost depends on the property’s age, location, property type, and the total time it took to complete the study.
Help your business reduce its tax burden and save money.
Cost segregation is a helpful tax strategy that can significantly help business owners and taxpayers lower their tax burdens. To learn more about cost segregation and stay current on other important financial topics, subscribe to our blog now!
