Do you own commercial real estate and are you looking to reduce the current income tax associated with your building? If so, a cost segregation study just might be your answer.
If you understand the concept of depreciation, you can understand the benefits of this strategy. Basically, the IRS views buildings as having a “useful life.” Generally, the IRS deems commercial buildings to have a useful life of 39 years. Your annual depreciation deduction is based on the value of your building divided by 39.
Cost segregation offers a way of potentially accelerating those deductions so that you realize the benefit over a shorter period of time. You may be able to “segregate” your building into various components, some of which would have a shorter useful life, and thereby accelerate your depreciation schedule and deduct a higher amount over a shorter number of tax years.
So, what types of properties might be good candidates for this idea? First, the ideal time to perform a cost segregation study is the year the property is either built or purchased. That would allow you to maximize the benefit by having higher deductions available to you from the very first year of the building’s useful life.
Second, since there is a cost associated with hiring a specialized firm to perform the cost segregation study, the value of your building should be high enough to justify the cost, which usually means owning a building valued at $500,000 or more.
Third, consider the type of building you own. A cost segregation study makes sense when the building has various components that have shorter useful lives. For example, a standard warehouse may not have separable components eligible for faster depreciation, but a warehouse with specialized lighting might offer the opportunity to depreciate the value of that lighting component more quickly. The same would be true of buildings that have a variety of fixtures and furniture; an expert should be able to identify which components would qualify for faster depreciation.
It is not uncommon for a cost segregation study to generate hundreds of thousands of dollars in net present value tax savings, depending, of course, on the owners’ tax brackets and the value and character of the building. And a dollar saved in taxes is a dollar earned.
What’s the potential downside? If and when you sell the building, you may have to “recapture” some or all of the depreciation deductions you took each year. That would be true, however, with any sale of a building that results in a gain. When considering the total financial impact, performing a cost segregation study often will outweigh this disadvantage. There may also be other Ideas and Opportunities that one could employ to mitigate this tax cost.
Of course, as we are financial advisors, not tax experts, and as such, we cannot give you tax advice. We recommend that you check with your tax advisor to determine whether a cost segregation study might be appropriate given your particular circumstances.