O’Connor’s blog series covering, is here to educate and guide you to conduct a successful cost segregation study, as well as the different methodology, requirements compliant with the IRS, and examples dependent on different components. Our cost segregation studies can benefit multiple types of property owners, including hotels, office buildings, retail centers, apartments buildings, warehouses, and retail centers.

What is Cost Segregation?

According to the IRS Cost Segregation Audit Technique Guide, cost segregation is a method of planning your taxes so property or real estate owners can increase their cash flow. Cost segregation, also known as a cost estimating technique, may be required to segregate costs to individual parts of property, such as land, equipment, furniture, etc.

Not only does a cost segregation study increase cash flow, but it also reduces current tax liability, defers federal income taxes, and provides depreciation recapture. Making a choice to do a cost segregation study can also help in keeping you compliant with IRS regulations. The use of cost segregation studies will increase; therefore, it is important to stay informed and prepared.

How does a Cost Segregation Study Work?

Let’s look at an example of a cost segregation study with the purpose of tax benefits. A construction project, regardless of scale, can include tangible property (§1245 property), such as computer and phone systems. In this case, you can allocate or segregate a portion of the project cost to the items. Both small and large businesses can benefit from a cost segregation study. You can find examples of our studies for Apartments, Hotels/Motels, Office Buildings, Shopping Centers, Retail, Drug Stores, Private Schools, Medical/Dental Buildings, and more on our website.

IRS Cost Segregation Audit Technique Guide

The IRS released their own cost segregation guide, Cost Segregation Audit Technique Guide, that goes over the ins and outs of cost segregation techniques, approaches, and elements. The technique guide is meant to help and educate property and real estate owners on the topic of cost segregation studies and how it can help in their property taxes. The technique guide provides a foundation for property owners with the right steps that will expedite the process and minimize any burdens.

To achieve an accurate cost segregation study, the methodology or approach used in distributing project costs to various assets is important. The different approaches mentioned in the technique guide are as follows:

• Survey or Letter Approach
• Residual Estimation Approach
• Sampling or Modeling Approach
• Rule of Thum Approach
• Engineering Approach from Actual Cost Records
• Engineering Cost Estimate Approach

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Bonus depreciation combined with cost segregation is a benefit property owners and real estate investors may be able to incorporate if it is identified as part of a cost segregation study. It is the ability to deduct a larger portion and as a result lower income taxes more significantly for owners of assets or property purchased in the first year. Thanks to the Tax Cuts and Jobs Act of 2017, property owners have the ability to deduct bonus depreciation at a rate as high as 100% on profitable commercial real estate investments, depending on the year of purchase! This means bonus depreciation allows you to deduct 100% of available depreciation on all asset classes with a depreciation life of 20 years or less for property purchased between September 27, 2017, through the end of 2022.

How does bonus depreciation work?

There are two things you need to know to make bonus depreciation work for you:

1. Purchase of an asset for profit; commercial asset

Purchase or build an asset and place it in service. Once purchased and in-service, existing tangible assets with a useful life of 20 years or less are eligible for bonus depreciation, which is currently at 60% through the end of 2024.

2. Available Bonus Depreciation

The bonus depreciation rate depends on when the asset was placed into service. The guidelines included in the TCJA – Tax Cuts and Job Act  currently provides 100% bonus depreciation for assets purchased after September 27, 2017, and before January 1, 2023. But starting in 2022, the 100% bonus depreciation began tapering off, with qualified property purchase in 2024 only receiving a 60% benefit. The table below displays the depreciation rates by placed in service year:

The bottom line

Bonus depreciation combined with cost segregation is an excellent tool for reducing federal income taxes for most commercial real estate owners. Act now to take advantage of remaining bonus depreciation on all “short life” assets. Short life assets are an asset with useful life predicted to be less than eight years.

For a fair assessment of how you can incorporate this process to reduce your taxes, take advantage of our free bonus depreciation calculator. Contact O’Connor to schedule a meeting to discuss how we may assist you in reducing your federal income tax burden.

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HOW DOES A COST SEGREGATION STUDY WORK?

A commercial real estate asset is a single entity made up of its various components, both interior and exterior to the asset itself. On average, 20% to 40% of those interior and exterior components fall under tax categories which may be written off much quicker than the building structure itself. A CSS dissects the property, determining the components that are eligible to be depreciated more quickly (i.e. 5, 7 and/or 15 years), as well as those that should be depreciated long-term (over either 27 ½ or 39 years depending upon asset type). The study allows you to accelerate depreciation deductions, thus reducing taxes and increasing cash flow. Due to enhancements to certain depreciation-related breaks under the Tax Cuts and Jobs Act (TCJA), the potential benefits are now even greater thanks to 100% Bonus Depreciation.

WHEN SHOULD A CSS BE CONDUCTED?

Many investors are a bit confused as to when to undertake a cost segregation study. Owners that acquire, construct or substantially improve a building, or did so within the previous year, should consider a cost segregation study. Additionally, if you are just learning about cost segregation, note that you have not necessarily missed out on an opportunity. The IRS allows us to perform “Look Back” studies on assets that you have acquired or constructed in previous years. Though Look Back studies are available, the best time to do a cost segregation study for new owners is during the year a building is constructed, remodeled or purchased, and BEFORE federal income taxes are filed for the ownership entity. This avoids the need for special form submission (form 3115), helping to limit out-of-pocket expenses.

To learn more about the cost segregation study, connect with us at Expert Cost Segregation.

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