What Is Cost Segregation?
Cost segregation is a strategic tax planning tool. It prohibits businesses or individuals to construct, buy, expand, and remodel any real estate. It helps them to grow their cash flow through accelerated depreciation deductions and deferred taxes. It can be from the state and federal income taxes.
The main goal of cost segregation study or analysis is to separate business assets into four visible asset categories:
- the personal property
- building structures
- land development
- land itself
In a simple term, cost segs is not a technical plan. It is stating the obvious. Cost segregation is a process of recognizing some important assets and the costs of each. Then you classify them in the right manner to be able to use them for a federal tax deduction.
So how it differs from the other work or tools used in totaling up the client’s possible deductions? Cost segregation is not only used for tallying up an individual’s expenses and place them in proper categories for deductions. Instead, businesses used cost segs if they want to identify a specific kind of asset allocation.
In other words, cost segregation is being used for reclassification and reallocation of a real property asset. By using this strategy, you can see the increase in the total amount of tax deduction in your asset. You are going to find out which assets are eligible to use in the future.
What is a Cost Segregation Study
How does a cost segregation studies or analysis work? Here’s a detailed overview. When one possession is being purchased, it does not include the building structure itself. All other parts of it, like the interior and exterior aspects, are also part of it. As an average, almost 20 percent to 40 percent of those other parts will fall as tax categories. It’s a must to include them in it as well.
The cost segs analysis will break down all the value of the construction. This also includes the price you pay when you buy the property that, in the long run, will depreciate over 27 and a half to 39 years. The goal of the cost segregation study here is to classify all other property-related values. These properties must depreciate over 5 or 7 to 15 years. As an example, a specific electrical outlet classified as equipment for appliances will depreciate in 5 years.
So, the cost segs studies, which are also known as cost segs, is being used as an accounting tool by several real estate investors. This is the best way to protect the capital and produce essential tax benefits. It’s possible because of the accelerated depreciation process and reclassification of assets. It’s an easier break down if assets are being disposed of. But with tax reform, investors these days are doubting if cost segs will benefit them in the future.
Benefits of a Cost Segregation Study
Real estate owners, especially in the commercial estate, can protect taxable income. These profits are from their real estate operations based on accelerated depreciation deductions. Protecting the taxable income means a consistent reduction in the value of income taxes you paid. This is from the current tax year that translates to an immediate increase in cash flow too. All these costs benefits are from the real estate operations you owned. It is an effective way in which real estate investors for commercial property may defer the payment for their income taxes.
Can I do my Cost Segregation Study, and how much it costs?
The best thing about the cost segregation study is that it allows property owners to take larger deductions. This is possible because of the front loading depreciation during the early or first-year life. The analysis will make sure to classify assets that separated from the structure of the building itself. It will identify items as General Depreciation System or GDS. And it will assign the other items a specific number of years to depreciate the property.
If you have no idea about different cost segregation studies, now you must know that it’s not cheap. It’s an expensive strategy or plan. The current rate of cost segregation in the market today is between $10000 to $20000. That’s a lot of money so you must use it the proper way. The main reason why it’s not cheap at all is the fact that it needs a complex study, and a professional will conduct it. Usually, it is an engineer who performs the study. But on the other note, you can also perform the analysis or study yourself if you have your CPA with you. This way, you can focus more on the items which will determine fair market value on your property.
Who qualifies for Cost Segregation and when to conduct it?
Commercial real estate you acquired or even built after the year 1986 qualifies for cost segregation. It will also include new acquisitions, buildings, constructions, or other property or land improvements. All these can qualify for cost segregation.
Professionals are recommending businesses to complete cost segregation studies as early as possible. The moment you buy, remodel or constructing a property in 1 year, then an immediate cost segs study must proceed. This is for business or an individual to take advantage of the income tax benefits.
Are soft costs depreciable?
They identified soft costs as an intangible value, not directing to particular construction work. They relate it to the construction itself of a specific building or other land improvements done with it. This means that it’s an item or personal property with capitalization involve when acquiring them. They are being included in the depreciating cost basis in the cost segregation analysis or study.
These kinds of costs include the professional fees for engineers or architects and the contractor’s fees. This also includes the rental costs of the equipment while on construction and the general condition of it. Permits fees and the builder’s insurance are part of the soft costs. Other miscellaneous not relating to the construction work is the real estate tax. It is sometimes included as the largest soft costs.
What is the Segregated Cost Method?
Segregation Cost Method enables an assessor to provide a separate concern to major constructions. This includes the system and all other components of the property with the least of time-consuming measures. Its goal is to come at constant replacement value at a reasonable time.
This includes the value of other parts of the property, such as ceilings, floors, and lightings. If the property increases, there will be a change of direction to the floor area too. Other costs of personal property may vary in relation to different parameters other than the floor area. But most of the costs related to floor area, roof area, and wall area serve as an individual count per installation. To help the application process of these individualized items costs, they are going to group themselves so you can add the total value.
Cost Segregation in Summary
If you are thinking of using cost segregation, you must speak to your CPA, especially for income tax purposes. They can identify whether it will be worthwhile for you to use this strategic plan. Some would say that the rate will only justify your tax savings in the long run. Remember that cost segregation can do the equation from ten thousand to hundreds of thousands based on tax law. It will always depend on personal property or building, especially with today’s current 100 percent bonus depreciation. Yes, it’s essential for the property owner to know the rate from bonus depreciation, too and how they will take advantage of it. Study everything first before jumping on it. It will only be a success if an investor pushes the right options for it.
Yes, you will benefit more from it, given the fact that there will be segregation analysis to consider. You have to make sure that you are working with the right and qualified professionals too. This is to ensure that they will be doing the study under the current audits and standards technique given by the IRS.
Cost Segregation is worth the effort. It is one of the best tax strategies for real property owners these days. The owner can increase their cash flow into their business and then reinvest all the tax savings from it to continue the growth of the business.