A cost segregation study identifies parts of a building that may qualify for shorter depreciation periods. Accelerating depreciation may reduce taxable income in earlier years, potentially improving cash flow.
Normally a commercial building depreciates over 39 years. But a building is not one thing. Carpeting, landscaping and specialized electrical work are not the same as the structure, and the tax code recognizes that.
A study separates structural components on the 39-year schedule from land improvements and non-structural elements, which can be depreciated over 5, 7 or 15 years.
The IRS recognizes cost segregation as a method for identifying assets that may qualify for shorter depreciation periods. A quality study typically uses detailed engineering and tax analysis to determine the appropriate classification of property. The IRS has since published its Cost Segregation Audit Techniques Guide, which sets out what a quality study looks like.
What it is worth
The benefit comes from timing. Reclassifying part of a building to a shorter schedule moves depreciation deductions earlier, which lowers tax in the near term and leaves more cash in hand now rather than later. The total deduction over the life of the asset does not change.
How much can be reclassified varies with the building. Industrial and manufacturing facilities generally contain more qualifying components than offices or warehouses, because of the mechanical, plumbing and electrical systems involved.
Components that commonly qualify include:
Mechanical, plumbing and electrical items
Landscaping and site improvements
Carpeting and floor coverings
Furniture, computers and phone lines
The amount reclassified and the tax effect depend on the building, how it is used, and the owner's own tax position. Only a study produces figures specific to your property.
Who is eligible
Any commercial property placed in service after 1986 can be studied. That includes new construction, property you have purchased, leasehold improvements you have made, and buildings you have expanded or renovated.
A study is more likely to pay for itself on larger buildings. An accounting firm can tell you whether one makes sense for a specific property before you commit to anything.
Property types that often benefit:
Offices and apartments
Distribution centers
Hotels and motels
Restaurants, including fast-food units
Medical centers and nursing facilities
Manufacturing facilities
Shopping centers and retail chains
Cost Segregation Studies
A cost segregation study draws on accounting, architecture, engineering and tax expertise. In its published guide, the IRS stated a preference for an engineering-based approach.
NexTrend Securities is not an accounting firm and does not provide tax advice. Cost segregation studies and related tax analysis are performed by an independent accounting firm with engineering and tax specialists.
Want to find out more about cost segregation, give us a call.
(972) 661-1283
