Whether you are a business owner or a consumer, you may have heard the term cost segregation when it comes to building, purchasing, expanding, or remodeling property. But what exactly is it and how you can enjoy the benefits?

What is Cost Segregation?

Cost Segregation is a strategic tax planning tool that allows for accelerated depreciation to increase cash flow, and can reduce any federal and/or state income taxes an investor may pay on rental income. It allows you to reduce your taxable income by having an analysis completed which provides the documentation needed when completing your taxes (The Cost Segregation Study). The process applies to both individual homeowners and business owners who own their property.

How Cost Segregation Studies Work

It’s important to hire a person qualified to create a cost segregation study to meet IRS requirements. Such a person can be a professional with experience in the following fields.

  • Architecture
  • Construction
  • Engineering
  • Tax Accountant

You should find out if a qualified individual will conduct the cost segregation study for your needs. The areas of the home or business that fall under the study will include the following.

  • Electrical, Phone, and Computer Systems
  • Carpeting, Wall Coverings, and Partitions
  • Concrete Slab Floor, Process, Piping, and Storage Tanks
  • Light Fixtures, Millwork, Ventilation, Special Plumbing, and More

The professional conducting the study will determine what qualifies as part of the cost segregation process. This means that you may need to have the professional conducting the study and your tax accountant coordinate to ensure that the area or items are covered under cost segregation before the study begins.

Recovery Period

This is the period in which the assets gained will start to depreciate. Such assets will be separated from those that do not need a recovery period. The qualification will depend on the type of property and the project that is undertaken. What determines this type of asset that may require a recovery period is not well defined as there are exceptions.

One guidepost is Chapter 6.4, known as Relevant Court Cases as part of the IRS’s Audit Techniques Guide or ATG. This provides some guidelines to determine the proper cost segregation course of action based on previous studies. Plus, the audit techniques and additional information that helps both professionals who conduct the study and homeowners or business owners who want to take advantage of cost segregation when the opportunity arises.

Potential Downside

Although the study itself may sound like a good idea for most home and business owners, there are considerable limitations.

Cost: A typical study in cost segregation may be upwards of $10,000 to $15,000. This puts it out of range for most homeowners as the cost will often exceed the amount spent on expanding or renovating the property. It is why those who own commercial properties or rental properties tend to benefit the most.

Recent Legislation

Tax Cut & Jobs Act (TCJA): This act which currently is in force allows business owners to take a bonus depreciation that reaches 100% of assets that are qualified under the cost segregation study on the first year. This is performed instead of the depreciation of the assets over a longer time period. However, this additional deduction will only be available until 2022 in its 100%.

It will then be phased out over the next five years until it is completely gone by 2027. So, if you want to take advantage of the deduction, this is the year to do it.