Increase Short-Term Cash Flow with a Cost Segregation Study
What is a Cost Segregation Study?
A cost segregation study is a federal income tax tool that increases your near-term cash flow by deferring taxes for residential and commercial building owners. This analysis provides an opportunity to write off up to 30-35% of your building’s original purchase price in the first year! “How can this be?” you might ask. The answer is simple. When you purchase a building, it depreciates as it ages and it loses value over time. In fact, the typical lifespan of a whole building is 27.5 or 39 years. But when you step back and really look at a building, it is not just one entity. It is actually made up of subcomponents like lighting, roofing, heating and air conditioning that also deteriorate over time. Unlike the whole building, these building subcomponents are granted 5- or 15-year lifespans by the IRS and, thus, make the building’s depreciation deduction much larger in the first few years of ownership.
How Much Money Could You Save?
Once you have a cost segregation study done, many building components can be written off immediately. Consider this: If your building purchase price is $2 million, you should be able to deduct $600k - $800k immediately. So, if you invested $200,000 of your own money and borrowed the other $1.8 million, you’d have spent $200,000 but received a $600,000 tax deduction! Let’s assume you are a roofing contractor, or you have a material interest in a commercial real estate investment, and you are making a $100,000 per year salary. Because you can apply this $600,000 deduction (30%) to offset taxable income, you are only required to pay taxes on $70,000! And the remaining deductions carry forward for future tax savings.
Do I Qualify for a Cost Segregation Study?
In short, yes! If you are an active corporation, individual or trust with real estate built or purchased within the past 15 years, with tax liabilities, you can benefit from a cost segregation study. This is true for both commercial and residential since a cost segregation study breaks out the construction cost or purchase price of the property that would normally get depreciated over 27.5 or 39 years.
When and How Often Do I Need a Cost Segregation Study?
A cost segregation study is most effective if it is completed upon original purchase of a property, before any renovations are made. A cost segregation study establishes a baseline to inform future tax treatment of depreciable assets. Once rehab is competed, you can revert back to the original cost segregation study and calculate your partial asset disposition. Post renovation, there are receipts and invoices that document the exact costs of the new rehab items. Using the cost segregation study (pre-reno) in combination with all receipts and invoices from the new rehab items, you have everything you need to apply bonus depreciation and partial disposition election/repair rules. It is much harder to document rehab costs if you wait until after the renovation is complete when an engineer is required for reclassification.
One of the most advantageous IRS tax savings programs available to building owners is a cost segregation study. As a Business Development Manager, I get asked a lot of questions about the program. Some commonly asked questions include:
What is a cost segregation study?
How much could I save having a cost segregation study completed?
How do I know if I qualify for a cost segregation study?
When and how often do I need a cost segregation study?
Let’s explore some of these questions and get the information you need to know.