There are times when you might have thought that the tax system is beneficial for the rich and the poor don’t benefit from it. Well, you’re mistaken, as you can also benefit from the tax system if you know how to use the system for your benefit properly. The rich use it for their benefit, and it is no surprise. They develop various techniques such as depreciation cost analysis or cost segregation to help them make a profit with the tax system.
1. What is the cost segregation method?
The cost segregation method is used by everyone, i.e., individuals, companies, partnerships, and LLCs. It is a tax-saving strategy that real estate investors use. This method helps the investors quickly depreciate the deductions that are essential for increasing the cash flow. They also use it, so they have to pay less federal and state income tax on their property from rental income.
When it comes to residential or commercial property, the real estate depreciation method is completely different. For residential property, the depreciation happens over 27.5 years, and in the case of a commercial property, the depreciation happens over 39 years. But the accelerated depreciation schedule allows the investor to save a lot of money on the taxes by writing more of the real-estate cost when the property was purchased or was being remodeled.
2. How does a cost segregation study work?
You can find out if you can use the cost segregation method by simply conducting a cost segregation study with the help of a professional. This study first identifies your real estate assets and then classifies them into numerous depreciation intervals. This helps the investor shorten the amount of time that is needed to depreciate the property gradually. It is done to help you reduce your ongoing income tax burden.
Property that has any non-structural building elements, exterior land improvements, and indirect construction costs is eligible for shorter depreciation intervals. The main goal of having a cost segregation study is to determine whether the investor has any costs related to construction that can be depreciated on a shorter schedule apart from the building. If the investor has any construction costs, then for a commercial property, the duration of 29 years for depreciation can be shortened to 15 years or less.
3. What are the advantages of having a cost segregation study?
As a taxpayer and investor, there are many advantages of conducting a cost segregation study, and they are as follows: –
I. You can free up some cash flow for your standard operating expense when you accelerate your depreciation.
II. You get to save a lot of money during the first few years of operation.
III. You can then put your tax savings into a short-term or a long-term investment as per your choice, and you do not have to worry about that.
IV. The study can help you eliminate any unfortunate audit adjustments that could pose a problem in the long term of the audit process.
V. Sometimes, you can also come up with some additional cash flow distributed among various partners of a partnership firm.
VI. It may also come up with new strategies or tactics that can help you save a lot of money on tax.
4. At what point must you decide to conduct the cost segregation study?
As per your convenience and requirements, you can conduct your cost segregation study. But there are some things that you must know before your start with the cost segregation method. Since only the time duration for commercial properties is 39 years, only the constructed properties, remodeled or expanded from 1982, can be included in the cost segregation method.
If you’re planning for a cost segregation study, then it is advised to do it in the year of purchasing or remodeling. This way you can get full benefits and also have more chances of saving some tax money. You can also do it when the project is in the construction stage to help you identify how you can save your tax money.
5. How can you use a cost segregation method to increase your annual depreciation?
It will be easier to understand with an example of how you can use the cost segregation method to increase your annual depreciation. For example, let’s say you have purchased a property worth $800,000. Once you buy the property, you spend around $200,000 on developing it. You remodeled it by adding a new landscape, a sidewalk, and building a new parking garage.
If you built the parking garage five years ago, you could have a catch-up on the deductions and claim depreciation deductions on your tax return since you didn’t claim for it before. It might also happen that you might also get bonus depreciation. This would help you get a larger amount on your deduction on the first year the property was purchased, constructed, or remodeled.
If you have queries about the cost segregation method of depreciation cost analysis, you can ask our experts from Lindon Engineering Services, Inc.