Cost Segregation is a strategic tax savings tool that allows companies and individuals, who have constructed, purchased, expanded, or remodeled any kind of real estate to increase cash flow by accelerating depreciation deductions and deferring federal and state income taxes. In general, it is easy to identify furniture, fixtures, and equipment (FF&E) that are depreciated over 5 or 7 years for tax purposes. However, a Cost Segregation Study goes far beyond that by dissecting construction costs that are usually depreciated over 27 ½ or 39 years. The primary goal of a Cost Segregation Study is to identify all construction-related costs that can be depreciated over 5, 7 and 15 years. For example, 20% to 50% of the total electrical costs in most buildings can qualify as personal property (depreciated over 5 or 7 years). Reducing tax lives results in accelerated depreciation deductions, a reduced tax liability, and increased cash flow.
What are the benefits of a Cost Segregation Study?
- Generates immediate increase in cash flow through accelerated depreciation deductions.
- Reduces income taxes and can also reduce real estate property taxes.
- Provides an easy opportunity to claim ‘catch up’ depreciation on previously misclassified assets.
- Provides an independent third-party analysis that will withstand IRS review.
When should a Cost Segregation Study be conducted?
The ideal time for a Cost Segregation Study can vary depending on a client’s tax situation. At ThreeFive, our team of tax experts work together with clients and their accountants to recommend the best tax planning solution to fit their needs. A preliminary analysis can help determine the right timing and strategy for any investor.
- Preconstruction: For investors who are in the planning phases of costruction or remodeling, this is the optimum time to consider a Cost Segregation Study as it is beforethe infrastructure of the building is set. ThreeFive’s Pre-Construction Consulting allows the project’s construction contractor to consider design alternatives to maximize tax benefits and the accountant and construction contractor to accurately track items that quality for accelerated depreciation, saving time and money.
- Year Placed in Service: The best time for a Cost Segregation Study for new owners, is during the year a building is constructed, purchased, or remodeled. This allows an owner to immediately optimize tax savings and accurately classify assets before the building even begins to depreciate.
- Post-purchase, Remodel, or Construction: “Look-back” Cost Segregation Study: A Cost Segregation Study can be completed anytime after the purchase, remodel, or construction of a property. In fact, current Internal Revenue Service procedures make it easy to go back and claim missed depreciation on assets acquired as far back as 1987 without amending prior tax returns.
What kind of real estate qualifies?
Any structure used for business or as rental property, is eligible for the benefits of Cost Segregation. The percentages of project-related construction costs that could be reclassified from 39-year real property to 5, 7, or 15-year property range from 10 to 60%.