Is your trade or business involved in constructing, renovating, or acquiring commercial real estate? Practically, any commercial owner will benefit from a Cost Segregation Analysis. These studies involve differentiating among various real estate and/or construction costs by allocating them to other asset categories and assigning a useful life that is unique to each asset for federal tax purposes.
The main goal of this study is to provide an opportunity for the commercial taxpayer to reduce his/her tax burden while still realizing the maximum amount of depreciation benefits. Keep in mind that this study should be performed concurrently with the purchase or construction of the property, and not after the fact unless the taxpayer is willing to amend previously filed tax returns.
Cost segregation studies enable commercial real estate owners to take advantage of the opportunity to reclassify certain real property that is currently classified under Internal Revenue Code (IRC) section 1250 as personal property under IRC section 1245. This reclassification generally results in a shorter useful life for tax purposes and the opportunity to use accelerated depreciation methods. These accelerated depreciation methods can increase your tax deductions and reduce your bottom line. For example, building costs that were previously capitalized using a 39-year life can instead be classified as a personal property using a 3, 5, 7, 10 or 15-year rate.
What are the Advantages?
There are significant compelling advantages to conducting a Cost Segregation Study. Overall, it reduces the current period’s taxable income by accelerating depreciation expense. Furthermore, it increases cash flow by deferring taxes in the current period, thus providing the taxpayer with opportunities for investment and growth. Moreover, this study allows the taxpayer to maximize depreciation benefits by claiming additional tax deductions like Section 179 and Bonus depreciation for federal and state tax purposes. This study follows only one principle, “a dollar today is worth more than a dollar tomorrow”!
ABC, Co. purchased a factory building for $1,600,000 on December 1st, 2015 and was placed in service a month later (01/01/2016). Included in the acquisition costs of the building were land, personal property (i.e. large machinery and equipment, small furniture and fixtures, etc.) and of course, the building. Without conducting a cost segregation study, the total acquisition price of the building ($1.6M) would be depreciated over a 39-year life, using the straight-line method; approximately $41,026 of depreciation expense per annum. If you were to perform a cost segregation analysis, the total purchase price of the building would be allocated as follows:
|Asset Class||Allocation of Purchase Price||Useful Life||Annual Depreciation (Est)|
|Machinery & Equipment||$250,000||7 yr||$142,863|
|Furniture and Fixtures||50,000||7 yr||28,573|
Based on the example above, we can clearly see the significant increase in depreciation expense of $151,329 ($192,355 of accelerated tax depreciation minus $41,026 of straight-line depreciation). By conducting a cost segregation analysis, we can conclude that the taxpayer was able to reduce their current period tax liability by taking the majority of depreciation expense up front as opposed to recognizing the same amount of depreciation over a 5 year period. These tax savings and increase in cash flow translate into one thing, more cash in your pocket!
Speak with your tax advisor or contact one of the expert CPA’s from MKS&H to determine if a cost segregation study is right for you.
Article Contributed by Maribel Loza
About MKS&H: McLean, Koehler, Sparks & Hammond (MKS&H) is a professional service firm with offices in Hunt Valley and Frederick. MKS&H helps owners and organizational leaders become more successful by putting complex financial data into truly meaningful context. But deeper than dollars and data, our focus is on developing an understanding of you, your culture and your business goals. This approach enables our clients to achieve their greatest potential.