By James Jenco
If you own virtually any kind of new construction or existing commercial real estate — housing, retail, industrial, institutional, health care, etc. — you may be able to realize tax and cash flow benefits that can come from conducting a cost segregation study.
As an owner, you are already taking advantage of depreciation for tax purposes. For instance, if you own a $10 million building, you can depreciate that asset and take an annual federal tax deduction of that value over 39 years.
Certain assets within a building depreciate at a faster rate than others and often need to be replaced before let’s say, 39 years. A single building consists of a large variety of parts and components. These components have various useful lives, and in many cases, these useful lives are less than those 39 years. Property owners consult cost segregation specialists — consisting of a team of engineers — to maximize their tax benefits by identifying, classifying and segregating the various assets that make up the building. The goal is to claim useful lives for depreciation of five, seven or 15 years on certain component parts of the building rather than defaulting to 39 years for the entire building.
As an example of the possible effectiveness of a cost segregation study, one real estate owner traditionally paid about $900,000 in annual income taxes. The first year of his company’s study resulted in a significant tax savings of around $800,000.
Here are the things you need to know about commissioning a cost segregation study:
- Advisability. Most building owners can benefit from cost segregation and accelerated depreciation, but some cannot. If you intend to buy and resell quickly, the tax benefit might not cover the cost of conducting the study. But for investors who hold on to property, it almost always makes sense. You might find that the immediate tax savings is significant enough to fund the down payment of your next real estate venture.
- Process. Your accountant can get the process started with a phone call. The engineering experts conducting the cost segregation study will initiate a site review and follow up with a report that will include court cases and IRS arbitration that set precedent for the depreciation claims made. Your accountant will file a Form 3115, Application for Change in Accounting Method, and this is automatically accepted by the IRS.
- Cost. The cost can vary depending on the size and complexity of the job and other factors, but most cost segregation firms will charge a fee in the range of $5,000 to $25,000 for the visit and report.
- Timing. The site visit by the engineer can usually be completed in less than a day, and your report should be ready in a few weeks but could take longer for a new construction project.
- Grandfathered benefit. As an added advantage, you can even get a segregation study conducted on a building you have owned for several years — and collect the accelerated depreciation benefits you have missed for all of those years.
Ask your accountant if you may be able to benefit from a cost segregation study.
James Jenco is a CPA at Wiss & Company LLC and performs audits, reviews and initiates cost segregation studies on behalf of commercial real estate clients. Contact him at firstname.lastname@example.org.
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