Filing Taxes
Bookkeeping
|
5 min. read

What is a cost segregation study?

building-inspection

And how can it get me a better deal on my taxes?

Few things affect your tax bill more than buying property. It’s often the single largest asset on a business owner’s books, and the tax liability can be huge. Any opportunity for savings helps.

That’s where the cost segregation study comes in.


The basics

  • Purchasing a building is a huge investment with far-reaching effects on your taxes
  • Assets depreciate over time, and depreciation leads to big tax deductions
  • Your building is not one thing, it’s a collection of different components that all depreciate at different rates
  • By cataloguing the various components that go into the construction of the building, you’re able to push depreciation forward as much as possible
  • Doing a cost segregation study means you get your big tax deductions as soon as possible

What is a cost segregation study?

A cost segregation study puts depreciating assets into the proper categories to reduce your up-front tax liability. Sounds good, right?

Depreciation

A used car is cheaper than a new car. That loss in value over time is depreciation.

But it’s not all bad. Depreciation also means tax write offs. When assets depreciate, you're not deducting the entire purchase from your taxes up front. Instead, you deduct a piece of that asset every year you use it. The IRS has tables that lay out the rate at which different types of assets depreciate (and yes, you have to follow their rules on this).

So how do we maximize that tax advantage?

Cost segregation

When you purchase a building, you depreciate that building over either 27.5 years (residential buildings, including multi-family housing) or 39 years (commercial buildings).  However, not every part of that building depreciates at the same rate.

First, there’s the land itself, which you don’t get to depreciate (and in fact it will tends to grow in value). Then there’s the building, which will depreciate over the 27.5 or 39 years outline above.

And you’re done.  Without a cost segregation study, that’s all you get.

But with a cost segregation study, you’re able to keep breaking things down further. Parking lot, plumbing, furniture, air vents, anything non-structural can be sorted into categories that depreciate in 5-15 years. That's much faster than 27.5-30 years!

This will frontload your tax savings as much as possible, and any money that stays in your hands – or goes back into your business – is a very good thing.

📑 Note: This goes even further when a rule known as “bonus depreciation” is
active. Under bonus depreciation, 100% of non-structural depreciation is pushed forward into the first year. Maximum up-front tax deductions. Pretty cool!


How does the study work?

Once you’ve decided to have a cost segregation study performed, you need to enlist a team of professionals. Cost segregation studies need to be performed by engineers and tax experts who have the necessary qualifications to officially sign off on the project.

Ideally, you’d be doing this for the year the building was acquired, but you can still have a cost segregation study performed within five years.

The team will inspect the site, noting everything that’s been done with the property. They will also consult building records, blueprints, and other available records. The land and the building are kept in the long-term assets category, and things like land improvements and non-structural building components go into the short-term assets category. These can include:

  • Landscaping
  • Parking lots
  • Handicap accessibility
  • Flooring
  • Lighting
  • HVAC

And, of course, much more. While they’re at it, they’ll also assess what the various components cost.

Tax savings

Let’s walk through an example to put numbers to this all.

Congratulations, you've just purchased a $2 million property for your business! 

  • We're starting with $2 million
  • We'll say 15% of that ($300k) is the land and 85% ($1.7 million) is the building and related assets.
  • With a cost segregation study, we find that 75% of the value of the building ($1,275,000) is for the building itself, while 25% ($425k) is for land improvements and non-structural building features.

Now that we've broken it down in a cost segregation study, let's compare the tax situation before and after (with bonus depreciation active).

  • Without a cost segregation study, the entire value of the building and related assets ($1.7 million) depreciates at the 39 year rate, leaving you with $43,589 per year in tax savings. Not bad.
  • With a cost segregation study, the value of the building's structure ($1,275,000) depreciates across 39 years, for $32,692 per year in tax savings. The other $425k? That's all deducted the first year. This leaves you with a $457,692 deduction your first year, and $32,692 each of the next 38 years.

You might notice that the total value of deductions available is the same for both situations. But just imagine taking that extra $425k in savings and investing it into growing your business. In 39 years, you could have a lot more than $425k to show for it.

Because real estate gets complicated and multiple legal structures may be involved, your ultimate savings might change based on your particular situation.  Make sure to review this all with your tax advisors first before making any decision so you understand if and how a cost segregation study can help you.

Bottom line

Buying property is very expensive, and it comes with a hefty tax liability. That tax liability will decrease over time as the value of the property depreciates, but that takes decades.

A cost segregation study gets you maximum tax savings right away. That’s money you can invest in your business now, increasing your earnings for years to come.

Want to learn more about cost segregation studies, along with many other ways to save on your tax bill? Schedule a call with our team at DiMercurio Advisors.

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