Cost Segregation Overview

Background

If you own a commercial/rental property or are a CPA, banker, real estate broker, builder, or architect you should know the term “Cost Segregation”. Cost segregation studies are most commonly prepared for the allocation or reallocation of building costs to tangible personal property. Property allocations and reallocations are typically based on criteria established under the Investment Tax Credit (ITC) laws under § 48. Because of the benefit of cost segregation the Internal Revenue Service states “The use of cost segregation studies will likely continue to increase”. (Cost Segregation Audit Techniques Guide – Chapter 1).

How It Works

A cost segregation study identifies and reclassifies personal property from real property assets to shorten the depreciation time for taxation purposes. This, in turn, reduces current income tax obligations. Personal property, or section 1245 property, includes assets that are non-structural elements. Other property such as land improvements can also be depreciated with shorter lives. The primary goal of a cost segregation study is to identify all costs that can be depreciated over a shorter tax life.

What Qualifies for Cost Segregation?

Parking Lots (asphalt)
Curb, Gutter, Sidewalks
Storm Drains
Irrigation Systems
Retaining Walls
Trees, Shrubs, Landscaping
Carpet
Countertops

Cabinetry
Blinds/Window Coverings
Auxiliary Lighting
Specialty Plumbing
Window Treatments
Wall Coverings
Removable Flooring
And more!

What Types of Buildings Qualify?

Apartment Complexes
Assisted Living Facilities
Auto and Truck Dealerships
Banks
C-Stores
Charter Schools
Data Centers
Day Care Centers
Dental Facilities
Distribution Centers
Funeral Homes
Golf Courses
Grocery Stores
Hospitals

Hotels
Industrial
Manufacturing Facilities
Marinas
Medical Offices
Motels
Movie Theatres
Office
Residential Rentals
Restaurants
Retail Stores
Self-Storage Units
And more!

What Type of Items Are Needed for the Study?

Building Costs, Deprecation Schedules or Settlement Statements, the address of the property, in-service date, and other information such as appraisals related to the building.

How will a Cost Segregation Study Affect My Tax Return?

The deduction created from the cost segregation study will directly reduce taxable income. Tax form 3115 allows taxpayers who placed buildings in service in past years to take the deduction on current tax returns. This means buildings placed in service at any time could qualify.

Example: A cost segregation study on an apartment building with a depreciable basis of $2M finds 32% of costs can be reclassified as shorter-life assets (20% 5-yr, 12% 15-yr). With bonus depreciation rules, all short-life assets are fully depreciated in the 1st year, resulting in an increased deduction of $664,727. Assuming a combined 40% federal and state tax rate, this results in tax savings of $251,345!