Has your business recently built or purchased a new building, or even renovated an existing building that you own? You may consider a cost segregation study to accelerate your tax deductions and increase cash flow.
Cost segregation is a tax strategy that allows commercial property owners to maximize current depreciation deductions by using shorter lives and faster depreciation rates for qualifying parts of the property. This isn’t a risky or aggressive tax scheme; in fact, court rulings date back to the 1960s to support the practice, and in 1997, the U.S. Tax Court ruled that the practice of segregating building costs for tax purposes was allowable.
A cost segregation study separates “real” or structural property from “personal” property, such as decorative fixtures. Once personal property is identified, it is analyzed and classified for federal tax purposes. The classification process includes assigning the assets acceptable depreciable “lives” based on the Internal Revenue Code, IRS guidance and case law. Then a report is developed that outlines the new classifications.
Commercial and residential apartment buildings are generally depreciated over 39 years and 27 ½ years, respectively, but a cost segregation study allocates portions of the purchase to shorter lives, allowing owners to depreciate those assets over 5, 7 and 15 years. This reclassification results in a significant deferral of taxes and an increase in cash flow for the owner in the years following the study. This is accomplished by accelerating depreciation deductions into earlier years, thus reducing income tax liability for those years.
For instance, if $400,000 in assets are reclassified as 7-year vs. 39-year property, the depreciation deduction in the first year would increase from about $5,000 to over $57,000, assuming the building was placed in service around midyear.
There are complex rules for distinguishing personal property eligible for accelerated depreciation from structural components that must be depreciated as part of the building. This classification depends on a number of factors, including how the property is attached to the building, whether it’s intended to stay in place permanently, and difficulty to move or remove.
Examples of personal property that may qualify for faster depreciation include:
- Decorative and security lights, as well as signage
- Cabinetry, shelving and decorative millwork
- Movable wall partitions
- Carpeting, vinyl floor coverings
- Security equipment
Even certain plumbing, wiring, heating and air conditioning vents and lines (which might typically be thought of as part of the building) may be eligible for shorter lives, if they’re specifically required for equipment that has a shorter life (like security system wiring).
Cost segregation studies can also identify land improvements that can be isolated, like parking lots, sidewalks, fences and landscaping.
Since cost segregation studies have so many variables to consider, the IRS requires working with an expert to ensure that all of the tax rules are followed. Kerkering Barberio has a dedicated construction team that works directly with a valuation expert to conduct a full building analysis, determine allowable depreciation benefits and ensure that all deductions are fully documented and verifiable.
If your business has recently bought, built or renovated property, you may benefit from a cost segregation analysis. Contact Shirley Fieber, CPA, at or 941-365-4617 to discuss your options.