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Identifying Opportunities for a Cost Segregation Study

August 22, 2019

Businesses…are you up to speed on cost segregation studies and how they can benefit you? Learn how to pinpoint opportunities where you’d benefit from a cost seg study.

Have you considered the benefits of a cost segregation study (CSS) for your business? For decades, businesses have used cost segregation studies to defer income taxes and improve cash flow. Although we’ve covered CSS in the past, we felt it would be beneficial to provide a “refresher” on this tax deferral strategy, how it has evolved in recent years, and how your business can benefit.

What is cost segregation?

For tax purposes, commercial property is typically depreciated over 39 years and residential property is depreciated over 27.5 years. Given that these are long periods of time, many buildings (or businesses) are sold before the property is fully depreciated. A cost segregation study, which is based on a comprehensive engineering analysis, identifies building components that can be depreciated over a shorter time period — typically 5, 7 or 15 years, depending on the type of asset, allowing your business to defer income taxes and increase cash flow.

What are the benefits of a cost seg study?

The main benefit of a cost segregation study is the deferral of income tax resulting in increased cash flow. In addition, under the recently enacted new tax laws (Tax Cuts and Jobs Act/TCJA), 5, 7 and 15 year property is eligible for 100% bonus depreciation, whether the property is new or used. Prior to the TCJA, only newly acquired fixed assets were eligible for 50% bonus deprecation.

Please note that in order for your business to qualify for the 100% bonus depreciation, the assets must be acquired after 9/27/2017.

So what does this mean?

Using the following example – your business purchases a new building for $5M. Real property, as mentioned above, is depreciated over 39 years. Utilizing a cost segregation study, let’s assume that $1M is deemed personal property and/or land improvements all depreciated over shorter lives (5, 7 or 15 years), and are eligible for 100% bonus depreciation. Therefore, in Year 1 that the property was placed in service, depreciation expense would be approximately $1,103,000, as a result of the CSS, ($1,000,000 of bonus depreciation plus $103,000 on the remaining $4M building depreciated over 39 years), and this is compared to only $128,000 without the CSS ($5M building depreciated over 39 years). As you can see the benefit in this example is significant.

An additional benefit is that the CSS creates a detailed baseline of asset values to support future asset disposals. In other words, let’s say in the next 3 years the roof on the building needs to be replaced. Without the CSS, a new roof would be added to the fixed asset list to be depreciated, while the old roof continues to be depreciated, because there is no information available to identify the cost of the old roof that was part of the initial building purchased. However, a CSS would have itemized the roof cost within the detailed engineering analysis, so that upon replacement of the roof, the old roof can be identified and written-off, which creates a deduction equal to the net-book value of the old roof that was disposed.

When should a CSS be performed?

  • Post construction or acquisition
  • Post significant capital improvements
  • Post ownership change (inherited property or change in partnership interest, for example)
  • Generally property with a depreciable basis of at least $1,000,000
  • You intend to hold the property for at least three years
  • On an existing property—look back study

What is a look back study?

Contrary to popular belief, a property does not need to be newly constructed to reap the benefits of a cost segregation study. A CSS performed on a property placed in service in years past, where a tax return has already been filed, is known as a look-back study. The IRS allows taxpayers to use a CSS to adjust depreciation on properties placed in service in prior years without having to file amended tax returns. The benefit of a look back study is that the depreciation that otherwise would have been taken in the prior years if certain components were depreciated over shorter lives is taken in the year that the CSS was performed. IRS Form 3115 (Change in Accounting Method) would be required to be filed with the current year tax return as a result of the look-back study

Wondering if a cost segregation study would benefit your organization? Contact us.

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