The Tax Benefits Of Cost Segregation Studies For Commercial Property

As a tax professional working with commercial real estate investors and developers, one of the most beneficial services I provide is a cost segregation study. Many of my clients who purchase or construct commercial buildings are unaware of this powerful tax planning strategy which can generate substantial tax savings and an improved cash flow. In this article, I will explain what a cost segregation study is, who can benefit from it, and how it can help optimize your taxes as a commercial property owner.

What Is Cost Segregation?

Cost segregation is an accelerated tax depreciation method available under IRS code section 168. It allows you to reclassify building costs into shorter depreciable life categories rather than standard 39-year depreciation for commercial real estate. A shorter depreciation schedule lets you deduct more depreciation expense in earlier years of ownership, resulting in increased cash flow, lowered tax liability, and an improved return on investment.

A cost segregation specialist will conduct a detailed engineering study of your property, identifying building costs that can be moved to 5, 7, and 15-year property classes from the 39-year classification. Examples include decorative window treatments, wiring, plumbing systems, custom HVAC components, security systems, certain landscaping costs, concrete floors with special coatings—the list is extensive of what can qualify.

The present value of the increased depreciation deductions typically ranges from 10-20% of the purchase or construction cost of a commercial building. The larger and more complex the facility, the greater the opportunities for accelerated depreciation. Cost seg studies can be performed on purchased, newly constructed, or previously owned properties.

Who Benefits From A Cost Segregation Study?

If you have recently purchased, constructed, expanded, or remodeled a commercial building, a cost seg study is an excellent tax planning strategy. It applies to all commercial property types including retail centers, medical office buildings, restaurants, assisted living facilities, hotels/motels, banks, warehouses, and manufacturing plants—to name a few. A cost seg delivers major benefits to owners of the following entities:

• Limited Liability Companies (LLCs)

• S-Corporations

• Partnerships

• Trusts

• Individual property owners

A cost seg allows these entities to accelerate depreciation deductions, shield more income, and minimize taxes owed in the early years of ownership or the placed-in-service year—increasing cash flow for other priorities like funding future projects, debt payments, or distributions to owners.

Additionally, a cost segregation study provides substantial benefits upon the sale or disposition of commercial real estate by increasing the return and reducing taxes owed on the gain. Since you’ve deducted more depreciation upfront, you’ve reduced your basis, which decreases capital gains exposure when you sell. Cost seg is a powerful tax planning tool whether you plan to hold property long-term or have a shorter investment horizon.

How To Get Started With A Cost Segregation Study

As with implementing any tax savings strategy, timing is critical to maximize the rewards. The best time to have a cost segregation specialist assess your property is immediately after acquisition or completing construction. Identifying assets that qualify for accelerated depreciation in the placed-in-service year allows the largest cumulative benefit going forward.

However, it’s never too late to analyze a building you’ve owned for several years. Through a detailed engineering analysis, construction cost documents, and tax returns from prior years, a specialist can prepare what’s called a “late” cost seg study. This look-back study retroactively adjusts depreciation from prior tax years with IRS approval, so you still receive sizable tax deferrals.

The process begins by having a professional engineering firm skilled in cost segregation document review and analyze your building systems and assets. Using sophisticated modeling tools and technology like 3D laser scanning, every aspect of your facility is examined to assess what components meet the complex IRS standards for shorter depreciable lives.

The engineering firm certifies an accurate cost segregation study documenting qualifying assets, estimated costs, placed-in-service dates, and revised depreciation schedules. This allows your CPA to calculate the tax impact and file Form 3115 for amended returns to claim the catch-up deductions. The cost study also provides the framework for future years’ tax planning.

Between the engineering expertise and tax law knowledge, cost segregation requires specialized experience. Hiring a reputable firm that strictly follows IRS procedures is crucial for sustaining a study upon an audit. A modest upfront investment in a quality cost seg study generates substantial tax incentives and five to ten times your initial costs in tax savings.

Uncover Funds Trapped Within Your Building Infrastructure

For commercial real estate developers and investors, a cost segregation study helps uncover funds trapped within your building infrastructure that can be freed up through accelerated depreciation. The tax deferrals directly impact your bottom line, increasing cash flow available for funding growth initiatives, leasing costs, upgrades, or financing payments on existing buildings.

As a professional tax advisor, my goal is ensuring clients maximize every available tax incentive to improve returns on real estate projects. A cost segregation study has proven to be one of the most lucrative federal tax-planning strategies I recommend for substantially increasing cash flow. By revealing this powerful tool early in your ownership timeline, I can help clients redeploy thousands of tax dollars annually to grow their investment portfolio or business.

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