Category

Cost Segregation

https://www.investopedia.com/financial-edge/0110/10-things-to-know-about-1031-exchanges.aspx

5 Reasons Cost Segregation is Important

By | Cost Segregation, Real Estate, Tax, Tax Incentives | No Comments

Higher profitability, lower tax liability, and increased cash flow are the three primary factors which make cost segregation so important. In addition, lower taxes and increased cash flow mean plans for the business can be crystallized and implemented more easily. Cost segregation is, therefore, part of the bedrock of success for real estate investors and developers.

Cost Segregation in Practice

Constructing, renovating, remodeling, and acquiring real estate for commercial use typically result in depreciating those assets over a 27.5- or a 39-year period. The timescale depends on whether they are residential (apartment blocks, single family homes, etc.) or commercial (shopping malls, hotels, warehouses, etc.)

By identifying specific, and IRS-approved, components that can be segregated from the rest of the real estate they can be allocated to accelerated depreciation categories. The three primary categories are land improvements, specific additions to the building’s core structure, and personal property. Those components may then be written off in 5, 7, or 15 years.

It is possible, therefore, to reduce income tax liability by up to $70,000 for each $1,000,000 of building cost basis owned. Specific savings are based on a detailed cost segregation analysis applying IRS-approved standards.

Making Use of Cost Segregation in Business

1. Simple Depreciation Acceleration

When a piece of real estate is constructed or acquired, there is usually a minimum time span before its value will increase enough for it to be sold at a profit. Maintaining the property generates costs; those costs should obviously be less than the corresponding income. Property and income taxes become payable. The amount of tax due is usually reduced by the 27.5- or 39-year depreciation write-off approach.

Cost segregation enables tax liability to be reduced. By shifting depreciation of approved components from 27.5 or 39 to 5, 7, or 15 years, that accelerated depreciation reduces each year’s tax liability. By reducing tax payments, cash for running costs, and capital for further investment is automatically generated. It does not have to be borrowed, attracted by exchanging company stock for new investment, or for corporate plans to be delayed.

2. Partial Asset Disposition

If the property is being renovated, then some components will be removed and replaced with new and improved components. The old and the new components will be depreciated. Unless partial asset disposition (PAD.) is taken, double depreciation of those old and new assets accumulates. This will impact recapture tax calculated at ultimate sale. By having previously segregated components into different asset classes, the recapture tax is reduced.

3. More Availability Means Greater Benefit

Cost segregation was once used, primarily, by major corporations. Today, properties with a cost basis in the hundreds of thousands as opposed to the tens of millions of dollars now qualify for accelerated depreciation. This, on its own, makes the principle both viable and important for the smaller investor or developer.

4. The Time Value of Money

A simple advantage of applying a cost segregation strategy is that money available today is worth more than ultimate profit made available at eventual disposition. By accelerating depreciation, even by a small amount on lower-value properties, cash flow improves. That cash becomes available for both running costs and for growth. When used for growth by investing in additional properties, components in those new properties can also be subject to accelerate depreciation, thus magnifying the benefit.

5. Cost Segregation and 1031

Relinquishing and acquiring real estate benefits from capital gains tax deferrals when managed via a 1031 Exchange. The increased profit generated by segregating costs is not, therefore, necessarily subject to immediate taxation payable on sale. All the tax can be deferred.

Personal as well as corporate investors can, by making use of The Tax and Jobs Act legislation, eventually avoid paying that tax if, when they move out of active property ownership, they reinvest in approved development zones. After an amount of time, the deferred tax is forgiven. The benefits of cost segregation can, therefore, be “held” indefinitely, and the benefits of recent legislation are increased.

The Takeaway

Cost segregation is important. It enables a business’s profit to increase and cash flow to improve by accelerating the depreciation on real estate components. The immediate and long-term benefits make it a crucially important strategy for real estate investors and developers. Completing cost segregation analyses correctly and to IRS standards demands competence in specific areas of real estate, and experience in tax law. To discuss how you can make use of this strategy, please click here to contact us.

What is Cost Segregation in Real Estate?

By | Cost Segregation, Tax Incentives | No Comments

For those working in the investment real estate business, a well-implemented cost segregation study will quickly be shown to accelerate depreciation and benefit your financial situation. By undergoing a study, real estate owners will take advantage of accelerated depreciation deductions and shelter taxable income. Doing so will immediately reduce the amount of income tax that the company or individual will have to pay that year, improving cashflow. For investors with estimated quarterly payments, these studies can also help defer the payment of their income taxes. 

HOW DOES A COST SEGREGATION STUDY WORK?

A cost segregation study is a rigorous process where a cost segregation engineer analyzes real estate assets and identifies property with shorter depreciation life (personal property) from the real property , which is what creates accelerated depreciation benefits. 

The goal of each cost segregation analysis is to separate holdings into distinct categories, or asset classes, that have different depreciable recovery periods. The four main categories and their typical depreciation lives are as follows:

  • Tangible personal property, which are non-structural components of a building (furniture, fixtures, carpeting, window treatments, and specialized plumbing and electrical components, for example) typically has a five to seven year depreciable lifespan.
  • Land improvements are components found outside a building’s footprint (sidewalks, paving or landscaping) depreciate typically over fifteen years.
  • Buildings depreciate over 27.5 or 39 years depending whether the type of property is residential rental or commercial.
  • The land itself, which is not depreciable.

THE IMPORTANCE OF A GOOD CONSULTANT

Cost segregation studies involve a lot of detailed knowledge of the regulations surrounding all tax incentive rules, so finding the right provider to guide you through each step is very important. The cost segregation consultant will find every component of your property that can be legally considered to be shorter life property and reclassify those assets to generate more depreciation deductions for income tax purposes. 

Once the study is finalized, the client will be provided with the information they need to calculate the accelerated depreciation deductions for income tax purposes.  The cost segregation report will also act as supporting documentation in the possibility of any IRS audit.  

In general terms, any piece of commercial real estate that was acquired, built, or put into service after 1986, including acquisitions, construction, building, or improvements- will be eligible for cost segregation.  

At Incentax, we help companies gain access to money-saving tax incentive programs at both the federal and state level. Our team is entirely made up of tax incentive experts and engineers, that guarantee a high level of quality in our work by offering audit support for free. For more information about our services or processes, contact us today!