Discover how cost segregation studies can maximize tax benefits and unlock hidden value in real estate investments. Learn about the process, benefits, and examples of cost segregation studies in this blog post.
What is Cost Segregation?
Cost segregation is a strategic tax planning tool used by real estate investors and their CPAs to accelerate depreciation deductions on commercial properties (including residential rentals).
By identifying and reclassifying assets within a property from real property to land improvements and personal property, cost segregation studies allow a shorter depreciation recovery period for those “segregated” assets. This can result in significant tax savings for the investors/property owner in the near term.
Traditional real property depreciation typically spans either 27.5 years, for residential rentals, or 39 years for all other commercial properties. By employing a cost segregation study, however, assets can be reclassified to shorter recovery periods, for example, 5, 7, or 15 years, and that’s before any bonus is taken.
From September 2017 to the end of 2022, for instance, bonus rules allow all assets built or bought during that time period, and being depreciated under recovery periods of 20 years or less, to take 100% depreciation in the first year. This means that the sum total of 5,7, 15 or any other recovery period identified in a cost seg can be deducted as an expense in year one.
Considering that Cost Seg studies are often identifying as much as 40% (sometimes more) of property assets (by value) into recovery periods that are 20 years or less, the tax savings can be incredibly substantial.
The Benefits of Cost Segregation Studies
Cost segregation studies offer several compelling benefits for real estate investors.
As outlined above, they provide immediate tax savings by front-loading depreciation deductions, resulting in substantial reductions in taxable income (especially when bonus applies). By doing this, investors are freeing up additional cash flow to be reinvested or used for other business purposes.
Furthermore, cost segregation studies, when implemented at the strategy level, can improve metrics on investment properties, e.g. by increasing after-tax income, making some deals more lucrative/attractive than they otherwise would be.
How Does a Cost Segregation Study Work?
Cost segregation studies are detailed analyses of a property’s components and associated costs.
The studies identify assets which qualify for shorter depreciation recovery periods by analyzing them in reference to IRS regulatory publications, established case law, and industry best practices.
These comprehensive studies provide a thorough breakdown of the costs associated with all segregated assets, allowing for precise reclassification and optimization of tax benefits.
Real-Life Examples of Cost Segregation Studies
To better understand the impact of cost segregation studies, let’s consider an example.
Suppose a business owner purchases a commercial property for $1 million. They expect to depreciate the entire amount over 39 years. However, through a cost segregation study, it is determined that $250,000 of the property’s value can be reclassified as a shorter-life asset. These shorter-life assets are eligible for recovery periods much shorter than the long-life recovery period, for instance: 3,5,7, and 15-year depreciation recovery periods.
Depending on the specific reclassification results, this can result in significant tax deductions and increased free cash flow over the long term.
Cost Segregation Services: Hiring the Experts
While the concept of cost segregation may seem straightforward, conducting a thorough and accurate study requires specialized expertise.
Hiring a professional cost segregation service ensures the study is conducted in compliance with the latest tax regulations to provide the maximum tax benefits. These services have a deep understanding of cost segregation methodologies and can navigate the complexities of the process, ensuring a comprehensive analysis tailored to your specific property.
This results in optimal study results that are robust to IRS audit.
Making Informed Decisions with Cost Segregation Studies
By conducting a cost segregation study, real estate investors gain valuable insights into the financial impact of their property. These studies provide a detailed breakdown of asset costs, allowing investors to make informed decisions regarding asset management, refinancing, and even future acquisitions.
With a clear understanding of the components and their associated values, investors can optimize their tax strategies and enhance their overall investment performance.
Conclusion
Cost segregation studies are a powerful tool for real estate investors and business owners seeking to unlock hidden value and reduce tax liability. By accelerating depreciation deductions, these studies provide immediate tax savings, enhance cash flow, and maximize return on investment.
To fully harness the benefits of cost segregation, it is advisable to engage a professional cost segregation service with the expertise and technology to conduct the highest level quality studies.
Complete Your Cost Segregation Studies Today
SegStream is a simple and easy-to-use software solution that helps CPAs, specialty tax firms and tax experts grow their businesses by completing more cost segregation studies in less time.
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With SegStream, you can complete cost seg studies with no previous cost segregation experience but if you consider yourself a pro, SegStream will turbo-charge your study production efficiency.
Schedule a demo today and learn how SegStream can help you grow your business.