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Cost Segregation Fundamentals

Cost segregation is not yet a well-known concept. If it were, virtually every real estate owner would use it broadly. Most real estate investors and many accountants have only a vague understanding of cost segregation benefits.

Cost segregation can be simply defined as the accurate allocation of the components of real estate. Cost segregation is not the same as component depreciation, although the result is similar. Tax laws ended the use of component depreciation in the early 1980s. Cost segregation became available in 1996. By correctly allocating the cost basis of real estate, it is possible to correctly, and more rapidly, depreciate real estate.

Most depreciation schedules include only land and long-life property (27.5 years for rental residential and 39 years for commercial property). However, many of the components of real estate have lives of five, seven and 15 years. By depreciating a component over a shorter period of time, the annual amount of depreciation is increased. Cost segregation typically increases depreciation by 50 to 100 percent in the early years of ownership.

Cost segregation increases an important non-cash tax deduction – depreciation. The tax benefits of increasing depreciation include tax reduction and deferred payment of federal income taxes. Income taxes are reduced since depreciation effectively changes the character of income from ordinary income to capital gains income. While the tax rate for ordinary income is up to 35 percent, the maximum tax rate for capital gains income is only 15 percent. Hence, the tax rate is cut by more than 50 percent. Federal income taxes are deferred from the year income is earned to the year a gain on the sale of that real estate is recognized. The net effect of additional depreciation is an interest-free loan from the federal government. For long-term owners of real estate, cost segregation operates to effectively eliminate federal income taxes (which it reduces) considering the time value of money.

Cost segregation is a powerful tool to reduce and defer federal income taxes by increasing depreciation. As it becomes understood more broadly, both real estate owners and tax preparers will use it frequently.

Cost segregation produces tax deductions and reduces federal income taxes across the country and in every size market. Below are just a few examples of where cost segregation generates meaningful tax deductions.

City:

  • Memphis, TN
  • Phoenix, AZ
  • San Francisco, CA
  • Houston, TX
  • New Orleans, LA
  • Los Angeles, CA
  • Boston, MA
  • Washington, DC
  • Las Vegas, NV
  • Philadelphia, PA
  • Columbus, OH
  • Allentown, PA
  • Boise, ID
  • Tulsa, OK
  • Charleston, SC
  • Worcester, MA
  • Sacramento, CA
  • New Haven, CT
  • Portland, OR
  • Durham, NC
  • Providence, RI
  • Buffalo, NY
  • Ft. Lauderdale, FL
  • Louisville, KY
  • Palm Bay, FL
  • Milwaukee, WI
  • Manchester, NH
  • Honolulu, HI
  • Virginia Beach, VA
  • Riverside, CA

Cost segregation produces tax deductions for virtually all property types.

Property Type:

  • Car wash facility
  • Department store
  • Shopping center
  • Power center
  • Lodging
  • Auto dealer
  • Drugstore
  • School
  • Mobile home park
  • Manufacturing/processing

Almost every industry, including the following, can generate cost-efficient tax deductions by using cost segregation.

Industry:

  • Automotive repair facilities
  • Real estate lesser
  • Textile product mills
  • Building supply dealers
  • Nondurable good wholesalers
  • Frozen food manufacturing
  • Beverage and tobacco product manufacturing
  • Apparrel manufacturing
  • Laundry facilities
  • Metal manufacturing

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