Typically, when an investor buys a piece of real estate, they view the value of the property is held in the land and the building purchased, but in reality, the investor bought much more! In the Internal Revenue Service’s mind, an investor not only bought the land and the building but also every component located on the land and building, from fixtures, flooring, cabinetry, parking stops, land improvements, and so forth. All these components should have a value assigned to them at purchase and, according to the tangible personal property regulations from the IRS, it is required to separately track these items. Yet, in many instances, investors list only land and building on their depreciation schedules because it is difficult to identify what value to assign to the other components. This is where cost segregation studies become an investor’s best friend.
A cost segregation study is an analysis of a property designed to reclassify assets to shorter asset lives and accelerate tax depreciation deductions. Generally, buildings are depreciated over 27.5 years or 39 years, but certain components can be reclassified into 5, 7, or 15 year lives. This results in accelerating depreciation into earlier years. In addition, with the Tax Cuts and Jobs Act, taxpayers were provided with favorable depreciation legislation that allows for certain assets in the shorter life years to be fully expensed in year one. This may result in a substantial tax deduction for the investor over the first few years in which they purchased their property.
To display tax benefits of a cost segregation study, let’s walk through an example. A real estate investor decides to purchase a $10 million property in March 2018. Below is a comparison of the depreciation deduction projection over the first five years without a cost segregation study and then with a cost segregation study.
As you can tell by the example above, the tax savings can be significant if an investor performs a cost segregation study. Additionally, a cost segregation study can be performed at any time, even if the investor has held the property for a couple of years.
Cost segregation studies provide an opportunity to uncover potential tax savings and increase cash flow by reclassifying property and ultimately utilizing the depreciation benefits sooner. If you would like more information on this topic please give us a call at 210.733.6611 or email us at office@atkgcpa.com.
Keeping it real as always,
