Cost segregation is an important (but often overlooked) tax planning tool. It can help businesses and individuals who have built, bought, upgraded, or expanded real estate investments accelerate depreciation deductions and defer state and federal income taxes. This strategy can save an organization thousands of dollars.
A cost segregation study allocates property-related costs into their appropriate classes, allowing you to calculate depreciation deductions more accurately. It also separates elements that are part of the building from those considered part of your business.
Here are six things you should know about cost segregation analysis:
1. What is a depreciation schedule?
Depreciation schedules typically allow for real estate depreciation over a 27.5-year or 39-year period. However, accelerated depreciation deductions mean that you can depreciate certain assets or elements on a shorter schedule—in 5, 7, or 15 years.
This method of segregating eligible real estate costs can result in substantial savings for commercial property owners. Unsure of how to get started? This assessment can help you understand if any renovations or improvements qualify for an accelerated depreciation schedule, allowing you to net near-term tax savings and cash.
2. Which expenditures qualify for cost segregation?
A cost segregation study involves construction-related expenditures that qualify for accelerated depreciation. The components in a cost segregation analysis include the following:
- Non-structural building elements
- Land improvements
- Indirect construction costs
3. Do assets like furniture or appliances qualify?
Personal real estate assets include items that aren’t considered absolutely necessary for a building’s operation and maintenance. Items such as furniture, home appliances, equipment, and vehicles qualify.
Additionally, land improvement deductions for tax purposes can include areas such as parking lots, walkways, fencing, driveways, and landscaping. Under cost segregation tax law, the IRS says that you can separate landscape elements into various parts such as security lighting, plants, trees, and rocks.
4. How do I qualify for bonus depreciation?
To qualify for 30, 50, or 100 percent bonus depreciation, the original use of the property should start with the taxpayer and the claim must qualify as one of the following:
- A MACRS property (modified accelerated cost recovery system) with a recovery period of 20 years or less
- Depreciable computer software
- A water utility property
- Qualified leasehold improvement property (acquisition requirements and placed-in service dates must be met in order to qualify for 30, 50, or 100 percent bonus depreciation)
- Indirect construction costs unrelated to the building’s value (e.g., architectural fees, trash collection, building appraisals, and construction management)
5. What’s excluded from cost segregation?
Cost segregation can be somewhat complex because costs aren’t always straightforward and depend on factors such as the type of building and property size. In some cases, the process of segregating costs and expenses is worth it for buildings valued at over $500,000.
6. Is cost segregation worth it?
Cost segregation isn’t applicable to every property, but this often-overlooked tax tool can save you thousands of dollars. Work with knowledgeable and experienced tax professionals who can help you decide if it’s worth carrying out a cost segregation study on a residential rental property or commercial real estate.
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