The Benefit of Cost Segregation

Knowing how to make the best use of tax laws will reduce a real estate developer’s tax liability while also increasing the company’s cash flow. Applying an effective cost segregation strategy is a successful way to achieve that result. Lower tax liabilities and increased cash flow both reduce the need for borrowing and speed up investor returns.

A follow-on result is that sound cost segregation frees up capital for the next land purchase, construction project, or remodeling phase.

Who Can Make Use of Cost Segregation?

This strategy can be used by a developer who may be starting with raw land and will then be adding infrastructure and part-finished or completed buildings which will then be sold on or leased out. Developers may also use cost segregation if they have purchased an existing building with a view to refurbishing it or converting it to a different use. The project to purchase, construct, or alter a building should be valued at a high enough figure for the tax savings to exceed the analysis and report preparation costs. This means the strategy is typically available to developers who:

  • Have recently purchased real estate or who intend to.
  • Have already or will construct a building or buildings on newly purchased or currently owned land.
  • Currently own or lease commercial property which will be renovated or converted from one use to another.
  • Have not previously used cost segregation to reduce their tax burden on a project, and who are eligible to recompute previous years’ depreciation deductions. Recomputing deductions usually means changing accounting methods from the previous years, which is why forward planning this aspect of accounting is so important.

What is Cost Segregation?

The strategy is founded on identifying and then segregating specific elements within development project into specific asset classes. Those classes are defined as being either personal or real property. The Cost Segregation Overview is covered in Chapter 6.3 of the IRS Audit Techniques Guide, but, briefly, the four asset classes are:

  • Land (which cannot be depreciated.)
  • Land improvements such as sidewalks and landscaping which can be depreciated over 15 years.
  • Buildings and structures which may be depreciated over 27.5 years for residential buildings such as apartment blocks, or 39 years for commercial buildings such as warehouses and manufacturing plants.
  • Personal property which may be depreciated over 5, 7, or 15 years.

Potential Asset Categories

It is possible to segregate a building’s internal and external components in such a way that 20% to 40% of the entire structure may be depreciated over 5 to 15 years, and not 27.5 or 39 years. Qualifying items and components which will attract accelerated depreciation include:

  • Concrete slab floors.
  • Doors, paneling, partitions, some floors and ceilings, crown molding, etc.
  • Electrical systems, certain plumbing and process piping, ventilation systems.
  • Specialized kitchen equipment.
  • Carpeting and wall coverings.
  • Computer systems, including dedicated electrical outlets, phone systems, and lighting systems.

Recent legislation has added other classifications making possible savings even greater. 2017’s Tax Cuts and Jobs Act enables developers to deduct a percentage of assets in the first year they are put into use. Eligible used property may attract a 100% allowable depreciation instead of the original 50%. This “bonus” feature will expire in 2022.

Working with a Specialist

The benefits of successfully preparing a cost segregation analysis and audit-supporting report are impressive. The larger the project, or projects, the greater the derived benefits of depreciation acceleration for reduced costs and increased cash flow.

In the same way that it pays to work with an architect or engineer who specializes in specific types of construction projects, it also pays to work with an experienced and successful cost segregation analyst. Existing projects can be analyzed and previous years’ tax liabilities can be recalculated.

Future projects can be worked on in such ways to ensure maximum and speedy results are achieved. Please feel free to contact us to discuss the topic in more detail, and so we can answer your questions. Please just contact us by clicking this link.