Does recapture diminish the value of a cost segregation study?

[Julio Gonzalez]

There is a common belief that recapture taxes diminish the value of performing a cost segregation study. However, this perspective overlooks the strategic advantages that a detailed cost segregation report provides. A cost segregation study is a strategic tax planning tool that separates the assets that have a shorter useful life and can be depreciated over 5, 7 and 15 years from the residential rental property or nonresidential real property that are depreciated over 27.5 and 39 years, respectively. By accelerating your depreciation schedules, you reduce your taxable income which in turn increases your operating cash flow.

Overlooked Benefits of a cost segregation study

A cost segregation study allows for property owners to more easily write-off assets that get damaged/destroyed as the value of these assets is determined as part of the study. For example, let’s say you purchased a building for $5,000,000. After having an engineered cost segregation study performed, the roof of the building was valued at $450,000. Later, a storm comes through and damages the roof. The roof now has an adjusted tax basis of $400,000 (due to depreciation over the years). Since you have the cost segregation study to provide proof of the value of the roof separate from the building, you can easily write off the $450,000 loss. If you had not had the cost segregation study performed, you wouldn’t have the $450,000 segregated from the rest of the building to easily write off the cost of the roof.

A cost segregation study also allows for property owners to more easily write off the disposal of fully depreciated assets through demolishing or scrapping the asset. There is generally no recapture associated with the disposal since there’s no sale or exchange generating a gain. The detailed cost segregation study report can help businesses more effectively manage their assets.

If assets don’t fall into one of the examples above, there are options such as a 1031 exchange, gifting them through a trust or other advanced tax strategies to avoid depreciation recapture. A 1031 exchange is a tax-savings strategy that allows investors to postpone paying capital gains taxes upon the sale of an investment property by reinvesting the proceeds through the purchase of another property (i.e. a like-kind exchange). There are specific requirements that need to be met for a 1031 exchange, so here’s the IRS fact sheet for further detail. Be sure to talk to your CPA and/or tax strategist about your options in your next tax planning meeting!

Have you utilized any of these strategies? What other benefits have you seen from a cost segregation study?