Here's how it works
Depreciation Basics
When you own a commercial property, you can deduct its cost over time to account for its gradual wear and tear. This deduction is known as depreciation. However, not all components of a building have the same useful life. The IRS provides specific depreciation schedules for different property types and features.
Identifying Shorter-Lived Assets
Cost segregation involves identifying components of a property that have shorter depreciable lives than the building itself. For example, HVAC, lighting, plumbing, electrical, and specific finishes may have shorter lives than the overall building structure.
Reclassification
Once these shorter-lived assets are identified, they are reclassified as personal property or land improvements rather than part of the building's structure. Private property and land improvements can be depreciated more rapidly, typically over 5, 7, or 15 years, compared to the 27.5 or 39 years for commercial buildings.
Accelerated Depreciation
By reclassifying these assets, property owners can accelerate their depreciation deductions. This means they can deduct a more significant portion of the property's cost in the early years of ownership, resulting in reduced taxable income and lower tax liabilities.
IRS Compliance
To ensure the cost segregation study is IRS-compliant, it must adhere to specific guidelines and regulations. This includes hiring qualified professionals, such as engineers or appraisers, to perform the study and producing detailed reports to support the reclassification of assets.
Cost segregation studies are invaluable for property owners, especially those with high-value commercial properties. It can provide immediate tax savings, increase cash flow, and improve real estate investments’ return on investment (ROI). However, it’s essential to ensure that cost segregation studies are conducted in compliance with IRS rules to avoid audit issues. It may seem obvious, but as professionals, we see an increasing number of studies that are poorly done and at risk of scrutiny from the IRS.
Remember that tax laws and regulations can change, so it’s advisable to consult with tax professionals or cost segregation experts who are up to date with the latest tax codes and guidelines before pursuing cost segregation for your property.
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Case Study
Medical Office Building in Los Angeles, CA
First Year Increased Depreciation: $1.01M
- Facility: Medical / Surgical Center
- Location: Los Angeles, CA
- Size: 10,000 SF
- Property: 1.5 Acres
- Building Basis: $2.9M
- First Year Increased Depreciation: $1.01M
