Cost Segregation - The Basics

[Malik Javed]

What is a Cost Segregation Study & How Does it Work?

Cost Segregation is a commonly used strategic tax planning tool that allows companies and individuals who have constructed, purchased, expanded or remodeled any kind of real estate to increase cash flow by accelerating depreciation deductions which can defer state and federal income taxes and increase cash flow.

When a property is purchased, not only does it include a building structure, but it also includes all its interior and exterior components. On average, 20% to 40% of those components fall into tax categories that can be written off much quicker than the building structure.

A Cost Segregation study dissects the construction cost or purchase price of the property that would otherwise be depreciated over 27.5 years for residential property or 39 years for commercial property. The primary goal of a Cost Segregation study is to identify all property-related costs that can be depreciated over 5, 7 and 15 years. For example, certain electrical outlets that are dedicated to equipment such as appliances or computers should be depreciated over 5 years.

Benefits of Residential Cost Segregation

Although the cost segregation process may appear complex, the benefits of conducting a cost segregation study on residential rental property are both practical and significant. Here’s how it can help if you currently own residential real estate:

• Improve Cash Flow – By taking advantage of accelerated depreciation, you can claim additional deductions in the early years of your property, boosting your cash flow. This can be especially useful during the first years of purchasing, remodeling, or constructing a property when budgets are tight and having money on hand can be beneficial.
• Reduce Tax Liability – When you categorize various components of a home’s exterior and interior, you can accelerate depreciation on these components. In other words, you will pay less in taxes by reducing your taxable income.
• Improve Efficiency – By classifying and identifying the various components of your property, a cost segregation study can help you maintain and manage the property more effectively in the long run. This improved efficiency can result in lower operating costs.

Key Considerations

If you own residential real estate, conducting a cost segregation study could provide substantial financial advantages. To make an informed decision, consider these essential steps:

• Seek out a Certified Cost Segregation Professional
• Consider their experience with tangible property regulations. Will they be prepared to address retirements and disposition? Repairs vs. capital expenditures.
• Find out how long the provider has been doing cost segregation studies and how many they have performed. This can indicate their level of expertise and reliability.
• Consider the resources available to the provider. Are they a nationwide firm? Do they have the necessary resources to stay on top of all the tax issues such as 1031 exchanges, 754 Step-Ups, etc.

Feel free to share your thoughts or comments.

[Eric Baker]

Quote from :

What is a Cost Segregation Study & How Does it Work?

Cost Segregation is a commonly used strategic tax planning tool that allows companies and individuals who have constructed, purchased, expanded or remodeled any kind of real estate to increase cash flow by accelerating depreciation deductions which can defer state and federal income taxes and increase cash flow.

When a property is purchased, not only does it include a building structure, but it also includes all its interior and exterior components. On average, 20% to 40% of those components fall into tax categories that can be written off much quicker than the building structure.

A Cost Segregation study dissects the construction cost or purchase price of the property that would otherwise be depreciated over 27.5 years for residential property or 39 years for commercial property. The primary goal of a Cost Segregation study is to identify all property-related costs that can be depreciated over 5, 7 and 15 years. For example, certain electrical outlets that are dedicated to equipment such as appliances or computers should be depreciated over 5 years.

Benefits of Residential Cost Segregation

Although the cost segregation process may appear complex, the benefits of conducting a cost segregation study on residential rental property are both practical and significant. Here’s how it can help if you currently own residential real estate:

• Improve Cash Flow – By taking advantage of accelerated depreciation, you can claim additional deductions in the early years of your property, boosting your cash flow. This can be especially useful during the first years of purchasing, remodeling, or constructing a property when budgets are tight and having money on hand can be beneficial.
• Reduce Tax Liability – When you categorize various components of a home’s exterior and interior, you can accelerate depreciation on these components. In other words, you will pay less in taxes by reducing your taxable income.
• Improve Efficiency – By classifying and identifying the various components of your property, a cost segregation study can help you maintain and manage the property more effectively in the long run. This improved efficiency can result in lower operating costs.

Key Considerations

If you own residential real estate, conducting a cost segregation study could provide substantial financial advantages. To make an informed decision, consider these essential steps:

• Seek out a Certified Cost Segregation Professional
• Consider their experience with tangible property regulations. Will they be prepared to address retirements and disposition? Repairs vs. capital expenditures.
• Find out how long the provider has been doing cost segregation studies and how many they have performed. This can indicate their level of expertise and reliability.
• Consider the resources available to the provider. Are they a nationwide firm? Do they have the necessary resources to stay on top of all the tax issues such as 1031 exchanges, 754 Step-Ups, etc.

Feel free to share your thoughts or comments.

Such a great post @Malik Javed! With our background in construction and real estate, we started doing this as an in-house service for our property owners years ago. Before that, it was crazy to see the difference in quality of the methods and reports from their studies.

Who you hire to do a cost segregation study really can make a huge difference.