Why Cost Segregation?

Tax Professionals' Resource
July 19, 2013 — 1,583 views  
Become a Bronze Member for monthly eNewsletter, articles, and white papers.

Any individual or company owning a structure that is used for business or as a source of rent is eligible for cost segregation. Cost segregation reduces real estate property tax and also reduces income tax. The goal of cost segregation is to identify construction costs or individual components that depreciate over 5, 7, and 15 years.

What is Cost Segregation?

Cost segregation is a valuable tax saving tool. It allows companies or individuals who have commercial property, new construction, as well as acquired property to accelerate cash flow, depreciation deductions, and to defer tax. In simple terms, segregating personal assets as well as property assets and reporting the personal assets for tax purposes which will reduce income tax obligations. The Cost Segregation Audit Techniques Guide issued by the Internal Revenue Service (IRS) in 2004 provides general guidelines for IRS agents conducting cost segregation studies.

Cost segregation classifies real estate into 4 categories – personal property, land improvements, building, and land. Personal property depreciates over a 5 to 7 year period and uses a double-declining balancing method which generates maximum tax benefits. Furniture, window treatments, fixtures, and carpet come under the personal property category. Cost segregation saves a lot in total present value savings.

Need and Application

Besides immediate tax savings and an increase in cash flow, cost segregation provides advantages in insurance cost savings as well as estate planning. Any building purchased, constructed, remodeled, or expanded since 1987 is eligible for cost segregation. The IRS guidelines state that a study done by a person with no construction background is not as reliable as a study done by a construction engineer.

The value of a cost segregation study depends on the following:

  • Cost of the study
  • Tax status of the owner
  • Building type and use

Benefits of Cost Segregation

Cost segregation benefits businesses in a number of ways while also providing lower taxes. Some of the benefits are as follows:

  • Provides immediate increase in cash flow through depreciation deductions
  • Reduces federal and income taxes
  • Reveals many opportunities to reduce real estate tax liabilities
  • If a building component needs replacement, the taxpayer can write off its remaining tax. This provides substantial tax benefits
  • Provides tools and information to correct misclassified assets and claim catch up depreciation

Cost segregation results in lower local realty transfer taxes. When a building’s value is reduced by cost segregation, the amount of transfer tax also is reduced, and additionally, the annual real estate tax may also be reduced. Cost segregation must be utilized to achieve maximum tax savings.

Cost segregation is often overlooked as the owners of commercial property are not fully aware of the potential benefits, the complexity of certain regulations, or if the property is purchased after the construction and appropriate information is not available. The financial benefits of cost segregation far outweigh the drawbacks. The cost of a cost segregation study varies depending on the type of property, size and complexity, as well as the quality of work by a particular provider.

Tax Professionals' Resource