A cost segregation analysis involves examining and reallocating engineering-based costs associated with building construction, renovation, or development. This could result in extra accelerated deductions and elevated cash flow if done correctly.
Cost-segregation studies, which evaluate the building’s components and allocate these various components with recovery periods, provide tax benefits to construction and real estate professionals.
You can benefit from a cost segregation assessment or study if you buy an existing building, develop a new building, or expand or remodel an existing building. In fact, all taxpayers in the commercial real estate sector – contractors, purchasers, renovators, and investors – may profit from a cost segregation analysis to determine which of their properties qualifies for accelerated deductions.
Residential rental property, including multifamily housing projects, actually depreciates over 27.5 years, whereas commercial rent property gets typically depreciated over 39 years. On the other hand, certain structural elements are eligible for shorter depreciation recovery spans of five, seven, and fifteen years.
Building costs are reallocated to the tangible personal property using such cost segregation studies.
Now that we have read about how cost segregations analysis helps in the depreciation of construction cost, let us now look into a few of the most frequently asked questions about the analysis.
1. When is the ideal time to conduct a cost segregation analysis?
The best time to implement a cost segregation analysis is the year when the property is put into service by its current taxpayer. Whether the property is new construction or an acquisition, it is best to maximize depreciation deductions in the first year.
Companies and architects can use an underutilized practice known as “tax engineering” at the blueprint phase to involve building designs that will increase tax savings for years to come.
2. What is the cost of conducting a cost segregation analysis?
The expense of conducting a cost segregation assessment can vary greatly based on the size, type, and structural complexity of the estate, as well as the quality of the service and their work results. This varying cost is due to the fact that not all cost segregation analysis studies are the same.
The cost for a cost segregation study should be based on time and skill or a fixed fee, but never on a contractual basis. This is because a contingency fee like this encourages the cost segregation specialist to be overaggressive and use improper estimating techniques in order to optimize their own profits.
3. What kinds of properties are eligible for cost segregation?
A cost segregation survey will be required for any commercial real estate held in service after December 31, 1986. Besides that, any size property is eligible. That being said, the cost/benefit analysis may rule out lower-valued properties as viable candidates.
Cost segregation usually begins to make sense for properties with a depreciable cost basis of $1 million or maybe more. When analyzing cost segregation for a leasehold improvement program, this value drops to the $300,000 range.
4. How much saving should I anticipate from a cost segregation analysis?
It is not surprising for a cost segregation study to result in net present value savings of hundreds of thousands of dollars or even more. The average study will allocate, or in the situation of a look-back survey, reallocate, anywhere from 20 to 40% of the depreciable prize to a shorter life.
The 10-year total value savings for every $100,000 relocated from 39-year to 5-year is approximately $28,000. (Depending on a 40 percent tax rate and a 6 percent discount rate). The net present value savings over 40 years is approximately $20,000.
5. Will cost segregation analysis expose me to an IRS audit?
You are not at any greater risk when purchasing new assets than when filing an income tax return. On the other hand, look-back studies necessitate the taxpayer filing a change of accounting method, which is evaluated by the IRS national office. Such studies could be sent to IRS units that specialize in cost segregation, where they could be chosen for audit.
While there are no statistics to support this, it is reasonable to assume that a look-back study is marginally more vulnerable to audit than a study performed on a property in its first year of operation. This is just one major reason why the IRS emphasizes the importance of working with a seasoned and qualified provider.
Preparing a cost segregation study necessitates an understanding of both the construction phase and tax law pertaining to property classifications for depreciation reasons. Choosing somebody or the segregation based on their credentials and level of expertise can have a significant impact on a study’s overall reliability and accuracy. It is time for you to conduct a detailed study to find the best consultant for your property’s cost segregation analysis.