One of the significant ways you can maximize your depreciation deductions is through a cost segregation study. Cost segregation studies can also reduce your tax burden when acquiring or developing real estate properties.

Even so, most investors, real estate owners, and tax advisors cost segregation analysis. The reason is simple. These individuals don’t understand how the study works or the end result.

So, what is a cost segregation study? Read on to learn more. 

A Cost Segregation Study

A cost segregation study refers to the process that examines every component of your real estate property, splitting them into varying groupings. As a result, you benefit from a hastened depreciation period for some of your property elements.

Generally, the depreciation period for residential rental property is over 27.5 years. For commercial real estate property, it’s over 39 years from an income tax perspective.

Remember, residential or commercial real estate properties are not just structures alone. These include your residence, warehouse, hotels, and office buildings.

Other included elements are plumbing fixtures, sidewalks, fencing, and carpeting, to mention but a few. You can decide to buy these assets by themselves but with a depreciation term of over five, seven, or fifteen years.

Usually, you’ll buy these elements as part of your real estate property development or acquisition. So, they become written off over a similar depreciation period as the other parts of your property. That is a 27.5 or 39- year depreciation period.

Performing a cost segregation study may take you between 30 to 60 days. Even so, the timing may vary depending on your real estate project size. Also, if you present all the needed information and documents early, you may take less time.

How Cost Segregation Works

Cost segregation studies aim to identify all your realty-related costs whose depreciation period is five, seven, and fifteen years. The study can also identify costs that can get written off faster with bonus depreciation.

So, your tax advisor team will review all your property records, details, and costs. The team also reviews your property blueprints and may conduct a physical inspection of your building.

Even though these documents are important, the study can still progress if you can’t locate all of them. If you’re acquiring a building, you’ll provide a closing statement, architectural drawings, and a site survey. Others may include the appraisal and your tenant list.

Who Performs Cost Segregation Studies?

It’s almost impractical to perform cost segregation analysis on your own. The IRS requires you to find a group of tax advisors and engineers.

The team will combine efforts and determine the elements of your property that should go into each set. Your group of professionals will also independently calculate the cost of each component in your building.

Remember, all commercial real estate properties are uniquely different. It’ll help determine if a cost segregation study is appropriate for your real estate property. To achieve this, connect and consult with your tax advisor about your available options.

It’s advisable to look for experienced tax advisors and engineers with not less than ten years of working experience. Also, you’ll need to find a licensed lawyer and a Certified Cost Segregation Professional, CCSP.

The Best Time To Get a Cost Segregation Study

You can organize a cost segregation analysis on your building in three different periods. These include:

• During the property acquisition
• After constructing the property
• After remodeling the building

Nevertheless, you can arrange for a look-back analysis any time you want afterward. Also, you’ll claim the consequential write-offs without having to change the previous year’s tax returns.

Why a Cost Segregation Study Matters

Real estate owners and investors can enjoy many financial benefits from a cost segregation analysis. Keep in mind that performing the study will have some up-front costs.

However, you’re guaranteed tax savings from the fast depreciation deductions. As a result, you significantly increase your cash flow over several years.

A cost segregation study provides the benefits of the time value for money. But, if you’re not planning on owning the property for an extended period, you may not realize any benefit from the study. This is because all the previous benefits will reverse once you sell the property.

Does Tax Reform Affect Cost Segregation?

Yes, it does! The new tax law allows additional depreciation for your property elements with a depreciation period of not more than 20 years.

Besides, you enjoy the bonus depreciation on acquired and new properties at a 100% rate throughout 2022. This is a double increase from the 50% rate under the previous tax law. As a result, a cost segregation study becomes more impactful.

Your costs and return on investment from a cost segregation study will rely on various aspects. These will include your property type, size, and other physical components.

Final Thoughts

What is a cost segregation study? This is an excellent opportunity for real estate property owners and investors to make significant tax savings.

Ensure your cost segregation providers follow the IRS guidelines. That way, you reduce your liability risks as you increase depreciation deductions and tax savings.

Browse this page for more information about cost segregation studies.