A cost segregation study is a tax planning strategy that many real estate entities take advantage of to increase immediate cash flows by accelerating tax deductions. As a property owner, one can take advantage of depreciation deductions to decrease taxable income. The IRS mandates commercial real property to be depreciated over a useful life of 39 years while residential buildings are assigned a useful life of 27.5 years. While the building itself has a long useful life, many of the components in the building will need to be replaced before then and therefore may qualify for a shorter depreciable life. A cost segregation study is completed by an engineer who breaks a single building into its various components and properly reclassifies each component for depreciation purposes. The study examines components such as floorings, ceilings, electrical, plumbing, walls, HVAC, and lighting. Once the different components of the building are determined, each category is assigned its own individual useful life. As a result, instead of having the cost of the entire building buried in the 27.5 or 39-year depreciation recovery period, portions of the building can benefit from a shorter depreciation recovery period by being classified as personal property, land improvements, or qualified improvement property often depreciated over a 5, 7 or 15 year period.
Cost segregation specialists often consist of a team of engineers working aside from certified public accountants. A cost segregation study can be conducted on constructed, purchased, or renovated property. It is important to keep in mind that cost segregation can be used on a building one has already owned for several years since the IRS permits catch-up depreciation treatment. In order to use cost segregation for a building previously place-in service by a taxpayer, the taxpayer must file an application for a “Change in Accounting Method” (Form 3115). Cost segregation studies are most beneficial to entities that own a substantial amount of real property with intentions to hold the property for several years. Cost segregation is a method of accelerating depreciation to defer tax and accelerate cash flow. If tax deferral aligns with your entity’s short-term and long-term goals it is a strategy to consider. Please speak to your WG tax advisor to determine if a cost segregation study is appropriate for your business.