Updated: Aug 7
With today's soaring inflation rate, real estate acquisition costs a lot of money, as does remodeling a house, shop, eatery, or warehouse.
But the good thing is that when buying, constructing, or remodeling residential or commercial real estate, investors have access to a federal tax planning tool that can help them increase their cash flows.
Cost segregation can provide you with the financial relief you need to invest in or construct real estate, despite the significant prices involved.
Here, let's talk about cost segregation and how to get the most out of it.
What Is Cost Segregation?
Cost segregation is a tax deferral tactic that identifies construction assets that can be depreciated more quickly than the usual 39-year procedure.
It translates to substantial tax-saving opportunities for taxpayers who have built, bought, or refurbished a facility.
To maximize tax deductions for past and present real estate investments, a process that integrates engineering, construction, and tax expertise is used.
How Do Cost Segregation Studies Work?
Cost segregation studies look at each component of property and speed up depreciation deductions for things like flooring, windows, fencing, and sidewalks, giving these things far shorter tax lifetimes than the typical 27.5 or 39-year period.
This study aims to identify all costs associated with the property that can be written off over 5, 7, and 15 years. Even better yet, most of these assets with 15 year or less depreciation lives are eligible for bonus depreciation or Section 179 depreciation so they can potentially be 100% depreciated in the first year.
Your advisory team examines the available property records, inspections, cost information, and designs to do this, and may also conduct a physical inspection of the property.
Who Will Benefit from A Cost Segregation Study?
If you have built or purchased investment real estate within the last 15 years, a cost segregation study makes sense.
A thorough cost segregation analysis is typically beneficial to any real estate owner who faces tax problems. The best candidates are businesses, partnerships, trusts, and individuals with:
Newly constructed or purchased property worth a basis allocated to the building of more than $1 million
Renovation, remodel, or leasehold improvements greater than $300,000
Benefits and Drawbacks
Potential Benefits of Cost Segregation
Cost segregation's key advantage is that it helps you save money. This is achieved by:drA
Accelerating the depreciation to be claimed on your investment properties: You can claim deductions for particular systems in your building, such as its electrical and plumbing fixtures, over 5, 7, or 15 years, as opposed to needing to depreciate a whole property over 27.5 or 39 years. Under certain circumstances, such as having positive taxable income, these assets are also eligible for bonus or Section 179 depreciation allowing them to be fully depreciated in the first year.
Lowering the annual taxes to be paid on your investment properties: You'll pay less income taxes on your investment property each year if you can claim a larger amount of depreciation.
Saving money: After paying your taxes, you'll have extra money, which you may use to buy more investment property if you want to expand your portfolio of properties
Potential Drawbacks of Cost Segregation
For real estate investors, cost segregation is a key tax tool. It does, however, have two major shortcomings.
It costs money. Although prices vary, a well-done study is not cheap. Typically, cost segregation studies and written reports cost between $5,000 and $15,000. Cost considerations include the property's location, the age of the building, whether it is residential or not, and the length of time needed to complete the development.
It takes time: A cost segregation analysis could take up to two months, again depending on the size and nature of your property.
How Is a Cost Segregation Study Performed?
A cost segregation study involves the identification and reclassification of assets within a property to gain tax savings. Here's how a cost segregation study is typically performed:
A feasibility analysis is the first stage in cost segregation research. This analysis determines whether the savings in taxes will make the study's cost reasonable.
The research takes into consideration elements including the property's age, price at the time of acquisition, and tax bracket of the owner.
Collect Property Information
The next phase is to gather data regarding the property after the feasibility analysis has been completed and it has been decided that cost segregation research is worthwhile pursuing.
This comprises blueprints for buildings, cost logs, contracts for construction, and other pertinent paperwork. A site inspection is frequently carried out to document the property's current state and spot any renovations or other modifications that have been made.
Analyze The Property
The information on the properties that has been gathered is then examined to find assets that can be classified for taxation. A group of tax experts and engineers with experience in cost segregation studies normally handles this.
To identify assets that fall within the categories of personal property, land improvements, or building components, they will do a cost analysis and examine the building plans and other documents.
A Complete Report
An extensive report outlining the study's findings is created after the assets have been located and classified. A thorough list of the reclassified assets, their values, and the new depreciation schedules are provided in the report. This study supports the tax reductions reported by the property owner.
Why Does A Cost Segregation Study Matter For Property Owners?
By frontloading depreciation deductions for classified assets, a cost segregation study enables property owners to maximize the depreciation of their real estate assets. A cost segregation study divides a building's assets into distinct categories and depreciation intervals for tax-related reasons.
What Makes a Real Estate Investment A Good Cost Segregation Study Candidate?
Not all real estate investments are made equal in terms of cost segregation studies. There are some properties that make better cost segregation study candidates than others. A real estate investment may be a potential candidate for a cost segregation study depending on the following elements:
Property type: Assets that can be classified for tax purposes are more likely to be present in certain kinds of properties. Cost segregation studies, for instance, may be beneficial for buildings with a lot of specialized machinery or equipment, such as industrial operations or medical offices.
Purchase price: The likelihood that a cost segregation analysis will be worthwhile is higher than the purchase price of a property. This is due to the increased prospective tax savings, which will make the study's expense more reasonable.
Age of the property: Because they are more likely to have assets that can be reclassified, newer properties are typically better candidates for cost segregation studies. The reason for this is that newer properties are more likely to have been constructed with assets that qualify for categorization and that tax laws have changed over time.
Renovations or improvements: Cost segregation studies could be a good fit for properties that have undergone sizable renovations or upgrades. This is because the cost of these upgrades can be reclassified and depreciated more quickly, leading to greater tax savings.
Owner’s tax bracket: A cost segregation study might be more advantageous the higher the owner's tax bracket. This is because owners who are subject to higher tax rates will benefit more from accelerated depreciation's tax savings.
Frequently Asked Questions
What Is Included in Cost Segregation?
Identifying assets within a commercial or rental property that can depreciate more quickly than the structure itself is known as "cost segregation." For example, plumbing, lighting, electrical systems, and flooring may be included. An in-depth examination of the property and its assets, as well as a report outlining the research's findings, are often included in a cost segregation study.
When Should Cost Segregation Studies Be Conducted?
Cost segregation studies can be carried out at any point following the acquisition of a property, but they work best when done immediately after the property is put into service. This is so that the early years of ownership can reap the greatest benefits from depreciation.
How Long Does a Cost Segregation Study Take?
The size and complexity of the property, as well as the study team's experience, will all affect how long it takes to finish a cost segregation study. The length of a typical study can range from a few weeks to a few months.
How Much Should a Cost Segregation Study Cost?
A cost segregation study's price will vary based on the property's size and complexity, the study team's level of expertise, and other factors. However, research can cost anything from a few thousand to tens of thousands of dollars.
Are Cost Segregation Studies Worth It?
Cost segregation studies are frequently a wise investment since they can result in substantial tax savings for property owners. To decide whether a study is worthwhile, you must evaluate the expense against the possible tax benefits.
Can I Do My Own Cost Segregation Study?
It is feasible to carry out your own cost segregation research, but it is not advised unless you have extensive engineering and tax law experience. Without professional assistance, it can be challenging to manage the cost segregation difficulties.
What Are the Risks Of Doing My Cost Segregation Wrong?
An inaccurate cost segregation study could lead to the misclassification of assets and possible tax fines. To make sure that the study is completed properly, it is crucial to collaborate with knowledgeable experts.
How Much Money Could I Save?
The owner’s age, tax bracket, and property size are just a few of the variables that will affect how much money can be saved by a cost segregation analysis. Cost segregation, however, frequently allows property owners to save tens of thousands or even hundreds of thousands of dollars in taxes.
Can A Cost Segregation Study Be Done Without a Tax Professional?
Although it is possible to carry out a cost segregation study without consulting a tax expert, it is not advised. Working with seasoned professionals is crucial since cost segregation involves complex tax law and engineering issues.
What Should I Consider When Selecting a Cost Segregation Provider?
The experience, reputation, and track record of a cost segregation supplier are key things to consider. Additionally, it's critical to confirm that they are knowledgeable about the kind of property you own and possess the qualifications necessary to carry out a thorough investigation.
How to Get Started?
Starting a cost segregation analysis is easy for us. Simply reach out, and we'll handle the rest!
Our team can conduct a free feasibility analysis remotely or visit your property in person to determine if cost segregation is a viable option for you.