Cost segregation is a way for commercial property owners to accelerate their tax deductions. Through this method, a real estate owner is able to depreciate the individual components that make up their property in the shortest amount of time possible. This allows for reduced tax liability and can be particularly helpful in the early years of a new business when liquidity is limited.
The process begins with an engineering-based cost segregation study that will separate a building into its components, such as the roof, the flooring or the electrical work. The study will also account for any equipment that may have been included in the purchase.
Without a cost segregation study, the taxpayer would simply use a straight-line depreciation to write off a percentage of the building’s cost over 39 years. However, with cost segregation, the taxpayer will be able to decrease his or her overall tax liability by separately depreciating each asset identified in the study. Many of these components will have a shorter life than 39 years, which will allow them to be written off much faster than depreciating the building itself.
How cost segregation works
Different components will carry different depreciable lives. For example, while electrical wiring and HVAC systems are depreciated over 39 years, carpeting and drapes are depreciated over seven years. Land improvements, such as sidewalks or landscaping, will also be identified in the study and are depreciated over 15 years. Once these assets are identified through cost segregation, the building owner can begin claiming each component separately for its proper deduction.
“Cost segregation gives a more accurate understanding of a property’s worth.”
The study may also provide a more accurate understanding of the property’s worth. Without the cost segregation study, a certain percentage of its value will be tied to land – a non-depreciable asset. The remaining value would then be gradually depreciated over 39 years. However, a cost segregation study will provide a more accurate assessment of the property’s value and may discover a lower percentage is actually tied to land than would otherwise be estimated. This increases the depreciable base while lowering the tax liability for the non-depreciable asset, the land.
Cost segregation can create substantial tax reductions for several years after a commercial property has been purchased. For small-business owners in the early years of their business venture, having additional funds can be especially helpful and allows for more investment in the business’ needs. Additionally, the study will identify the value of all the property’s assets, making it easier for the owner to quickly sell any of these components if desired.
For more information on how to get the most tax-efficient structure for a real estate purchase, commercial property owners in Texas and Louisiana should contact a member of the LaPorte Real Estate Industry Group.