Cost Segregation for Accelerated Depreciation

As this tax season has come and gone, investors are looking for possible strategies to minimize their tax liability next year. There are many options available, but investors can seek significant benefits when it comes to cost segregation for accelerated depreciation. However, is it the right move for your business? 

What does Cost Segregation for Accelerated Depreciation mean?

Finances in investing can seem a little confusing, even to the most experienced investor, because there are specific codes and regulations to follow (that are constantly changing). It is essential that investors fully understand all parts of their financial decisions for financial success. Here are the definitions to know surrounding cost segregation: 

• Depreciation
  In real estate, depreciation refers to the loss of an asset’s value over time. Most real estate suffers from normal wear and tear over the years, making it less valuable as it ages. The IRS allows commercial property owners to deduct those losses from their overall tax burden.How can investors calculate depreciation? Like most things pertaining to taxes, the IRS has guidelines about depreciation, and property owners must adhere to those guidelines. The “useful life” of your property determines the depreciation value. The type of property you own determines its useful life.
• Commercial Real Estate Depreciation
  Commercial properties are defined as anything used to manufacture or sell goods and services. According to the IRS, commercial properties have a longer “useful life.” Commercial real estate depreciation is calculated by dividing the cost basis by a 39-year useful life. This amount is used to lower the annual tax burden.

 

So, what is Cost Segregation, and will my business benefit from it? 

Cost segregation is a tax strategy that converts traditional depreciation into asset-based depreciation. This strategy can accelerate the depreciation rate, lowering the owner or investor’s annual taxable income.

Here’s a quick video from our friends at The Anderson Group explaining cost segregation for 2accelerated depreciation.

How Does Cost Segregation for Accelerated Depreciation Work? 

Due to the Tax Cuts and Jobs Act of 2017, real estate owners can accelerate the depreciation of their properties, therefore reducing their annual tax burden each year2.

Step 1: Contact a tax expert 

It’s important for owners or investors to contact an expert real estate tax specialist or accountant professional to discuss cost segregation and accelerated depreciation and investment strategies regarding their specific business. No two companies are alike or will follow the same strategic plan to success. If tax deductions are completed improperly, this could become an IRS tax nightmare. 

Step 2: Conduct a cost segregation study 

The owner or investor must have a cost segregation study done to qualify for accelerated commercial real estate depreciation. This study will identify the real property and assets –  assets that aren’t the building themselves and personal property – and assign depreciation values to those items.

These studies can be very costly, so weighing the costs and benefits of transferring property to an accelerated depreciation category is important.

If possible, investors should have a cost segregation study done as soon as they purchase, build, or renovate a property. To realize maximum tax benefits, the owner must have this study completed within one year of purchase. 

Step 3: Use The Cost Segregation Study to Lower Taxable Income 

Once the cost segregation study is complete, investors and owners can use these assets to offset their taxable income.

For example, let’s look at depreciation on an office building and how cost segregation for accelerated depreciation would apply.

Example: 

An investor purchases an office building for $10 million but does not conduct a cost segregation study. The depreciation rate would be the cost basis (the total purchase price, minus other considerations) divided by 39. Assume the cost basis for this property is $9 million. The annual depreciation on an office building would be roughly $230,800 annually.

However, a segregation study was conducted that determined 10% of the property’s assets are “personal property” (items that could be removed from the property). This is because those assets have much shorter useful life spans. So, assuming $1 million of that $10 million office building is “personal property,” the investor can claim the $1 million as depreciation. Therefore, they can write off these assets during the first year, significantly reducing the overall tax burden.

Additionally, these assets depreciate faster than real estate as a whole. Depending on the segregation study findings, most assets have a “useful life” of as few as five years. Therefore, these office buildings’ annual tax burden and depreciation are magnified. This method could save tens or even hundreds of thousands of dollars per year.

So, is cost segregation the right strategy for minimizing my business tax liability? As stated in step one, investors and owners are highly encouraged to contact an expert. At Lumicre, LLC, we specialize in real estate tax advisory and consults to determine the best business decision for our clients. Contact us today if you are looking for more information regarding strategies to limit taxable income.