The Tax Benefits of Cost Segregation in Real Estate
Cost Segregation Basics
Real estate investors can obtain significant tax benefits by using a popular asset depreciation technique called cost segregation. Using this process, purchasers view a real estate acquisition as not only that of the building and land, but also as tangible personal property and land improvements.
Tax savings come in the form of accelerated depreciation deductions. Rather than depreciate the entire real estate asset over 39 years, by segregating it into its four different components, the property owner may accelerate depreciation on part of the asset. A cost segregation study also enables property owners to defer federal and state taxes.
A cost segregation can be used in newly constructed buildings or buildings currently under construction, existing buildings undergoing expansion or renovation, newly purchased existing buildings, and tenant leasehold improvements.
How Cost Segregation Works
Typically, the entire cost of the commercial real estate is depreciated over 39 years. However, during a cost segregation study, components of a property or leasehold improvement that may be depreciated over a shorter time (e.g., 5, 7, or 15 years) are identified and reclassified.
A real estate investor’s advisor will typically retain a firm that specializes in cost segregation studies to conduct the assessment. The firm’s engineering report will segregate the assets into four categories:
1. Personal property
2. Land Improvements
Assets allocated into personal property and land improvements will have shorter useful lives when compared to a building, and therefore employ accelerated depreciation methods.
Personal Property – Typically depreciated using a five- or seven-year recovery period. This usually includes carpeting, furniture and certain fixtures such as decorative lighting.
Land Improvements – These also have a shorter life (typically 15 years) and are subject to an accelerated depreciation method. They include landscaping, sidewalks, fencing, and signage.
Building – After personal property and land improvements have been segregated, a buyer should maximize the allocation to the building(s), as any remaining property value will be allocated to non-depreciable land. Residential and commercial buildings are depreciated using the straight line method over lives of 27.5 and 39 years, respectively.
Land – Land is a nondepreciable asset and provides no current tax deduction for depreciation.
When to Use Cost Segregation
Any company or individual who has purchased, constructed or expanded commercial or rental residential real estate since 1986 may qualify for a cost segregation study. Commonly, a cost segregation study is recommended for buildings worth more than $1 million. The goal is to reduce the property owner’s tax obligation and increase cash flow.
Does your commercial real estate qualify for a cost segregation study?
Do you have questions about how this might provide tax benefits as the commercial property owner? Contact us for more information about this valuable asset depreciation technique at (201) 655-7411 or email our real estate expert, Simon Filip, at sfilip@KRScpas.com.