Definition
Cost Segregation is a tax strategy employed in the realm of business and investment property to identify and reclassify specific assets within a property that can be depreciated over shorter periods. Instead of depreciating the entire property over a standard timeline (such as 39 years for commercial real estate), cost segregation allows for certain nonstructural elements, indirect construction costs, and exterior improvements to be depreciated more rapidly, typically over 5 to 15 years. This results in substantial early tax savings and improved cash flow.
Examples
- Restaurant Property: Elements such as kitchen equipment, countertops, and lighting fixtures may be classified as personal property, enabling a depreciation period of 5 to 7 years instead of the entire building’s 39-year schedule.
- Office Building: Items like office furniture, specialized electrical outlets, and unique lighting fixtures can be segregated to apply depreciation over a shorter life span, perhaps 7 to 15 years.
- Manufacturing Facility: Specialized machinery, specific sections of plumbing, or electrical systems used exclusively for the manufacturing process can qualify for accelerated depreciation.
Frequently Asked Questions
What is the primary benefit of cost segregation?
The primary benefit of cost segregation is the ability to accelerate depreciation on eligible property components, providing significant tax benefits and improved cash flows during the early years of property ownership.
Who can benefit from cost segregation?
Businesses and individual investors who own, construct, renovate, or acquire commercial real estate properties can benefit from cost segregation studies.
How is a cost segregation study conducted?
A cost segregation study is generally conducted by qualified professionals such as engineers, accountants, or tax experts with expertise in construction and tax law. They assess the property to identify and segregate components that qualify for shorter depreciation periods.
How much can I expect to save with a cost segregation study?
The amount you can save will vary based on the specifics of the property—its purchase price, type, and the extent of eligible assets. However, tax savings can be substantial and may significantly outstrip the cost of the study.
Is cost segregation only available for new properties?
No, cost segregation can be applied retrospectively to properties already in use. Existing owners can apply the findings to adjust previous year’s tax returns and potentially generate refunds.
Are there risks associated with cost segregation?
Yes, there are risks, mainly related to the complexity and fluidity of tax laws. Incorrect or overly aggressive segregation could result in penalties. Therefore, studies should be conducted by qualified professionals.
Related Terms
- Depreciation: The reduction in the value of an asset over time, which can be expensed annually for tax purposes.
- MACRS: Modified Accelerated Cost Recovery System, the current tax depreciation system in the United States.
- Section 179: A tax code allowing businesses to deduct the full purchase price of qualifying equipment and/or software purchased or financed during the tax year.
- Tax Deferral: The practice of delaying tax liabilities to future periods, an inherent benefit of accelerated depreciation.
Online Resources
- Internal Revenue Service (IRS) - Cost Segregation
- NAI Global - Cost Segregation
- Deloitte - Understanding Cost Segregation
References
- Internal Revenue Service. “Cost Segregation Audit Techniques Guide,” January 2017.
- Deloitte. “Understanding Cost Segregation,” 2020.
- Ernst & Young LLP. “Maximizing tax savings with cost segregation,” April 2018.
Suggested Books for Further Studies
- “Depreciation of Real Estate A Complete Guide on The Deployment of Buildings Cost With Cost Segregation Analysis & Techniques” by Neal C. Thomas
- “Cost Segregation: Classifying Components” by Janel M. Chew
- “Accelerate Depreciation on Your Property with Cost Segregation Analysis” by Joseph C. Cerne
