For many years, accounting firms have relied on cost segregation as a tool to preserve capital and help their clients benefit from massive tax relief. Through accelerated depreciation, reclassification of assets, and write-downs, a business can reduce their tax burden significantly and free up cash.
Despite the effectiveness of cost segregation in the past, new tax reforms that went into effect on January 1st, 2018, make cost segregation more beneficial by offering additional depreciation classification, and a rate of up to 100% for new and acquired properties up from 50%.
But cost segregation for real estate is not for everyone or every business. There are a few things you need to know to help you make the most out of cost segregation.
1. It is not for all properties
The benefits of cost segregation are limited to specific properties and beneficiaries. To qualify for cost segregation, the property in question needs to meet the following criteria:
- The property should be an investment property.
- Permanent residentials that don’t depreciate because of the ownership structure are also considered.
Additional requirements for properties or companies to qualify for cost segregation include:
- Companies that have recently constructed, purchased, or are planning to buy or construct a building.
- Company-owned or leased buildings that have been recently renovated.
- The construction, renovation, or purchase cost of the building in question should have cost $300,000 or more.
If the property meets the above criteria, cost segregation could help the company make substantial savings from tax deductions and instantly improve cash flow.
In addition to the criteria, the application for cost segregation must meet the rigorous application and requirement procedures of the IRS.
2. The cost is not straightforward
Most companies that have applied for cost segregation have quickly realized the process is not as straightforward as it looks.
A cost segregation study is not inexpensive, even for an average study. Before jumping in feet first, the expected savings must significantly outweigh the cost of the study.
A cost segregation study starts anywhere around $10,000 and could cost as much as $25,000 for a well-done study and a written report.
Even with the budget, not all properties qualify because the study is only one step of the process. To give yourself the best chance of success, you have to ensure you check on all the right boxes. Some requirements include:
- Either you, your spouse of the both of you are real estate professionals.
- Your W-2 income falls below $150,000.
- You’re selling the property.
Other than the typical costs, additional charges depend on the location of the building, whether the building is new or existing, and the nature of the property.
There are also other charges that you might incur down the road. To ensure the trouble is worth your while, it’s necessary to involve your accountant to make sure you can qualify for cost segregation before you start the application process.
3. Cost segregation application doesn’t follow the calendar year
Unlike other tax processes, cost segregation doesn’t have to be determined by December 31st. You can do it in March or April of the prior tax year.
It can be done at any time of ownership, even by the current owners, which means time is not a limitation, and you can start enjoying the tax deduction at any time. You can also extend the study to other rental properties in your portfolio.
Using the savings you accumulate on one property, you can offset the other properties, or even offset your active W-2 income taxes.
Even though you’re not pressed for time, you can make more savings by requesting for a cost segregation study the year the property is placed in service by the current taxpayer.
Making the most out of cost segregation requires a strategic approach with the help of an expert who understands the process. If you would like to know if you qualify for a cost segregation study and learn more about this monumental tax-saving opportunity, get in touch today.