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Building or remodeling your office? A one-time tax savings opportunity may be available.

Sept. 6, 2019

Cost segregation study – the basics

Individuals and companies that build, purchase, remodel or expand any kind of real estate can benefit financially from using cost segregation. The purpose of a cost segregation study is to identify personal property components that can otherwise get buried in the lump-sum costs of the building purchase or construction project, which typically end up classified as real property. A cost segregation study can unearth those assets and recover their tax value. Further, it increases cash flow by deferring taxes and typically creates tax savings of 2% to 5% of the total basis of the property. While the primary benefit is present-value tax savings, permanent tax reductions often occur as well.

Real property and personal property explanation

With the main objective being the classification of real property versus personal property, you may be asking, what’s the difference?

Real property: A building and its structural components. This property is typically depreciated over a 39-year life.

Personal property: Carpeting, cabinetry, wall coverings and fixtures. This property is typically depreciated over a five or seven-year life.

What’s the benefit?

By completing a cost segregation study, items typically classified as real property can be identified as personal property, opening the door to shorter depreciable lives. In addition to the shorter lives, personal property also offers accelerated depreciation methods that may be available in the first year of use, resulting in an even higher, immediate deduction. All of these factors allow for quicker depreciation deductions, which result in lower taxes in the early years after the project.

One example of the type of item a cost segregation study can unearth is related to electrical costs of the project. In many cases, electrical components are likely to be capitalized as part of the building due to the nature of electricity benefiting the entire building. However, if the electrical component is dedicated directly to equipment, such as a dental chair or tools, then this may be able to be classified as personal property versus real property.

A cost segregation study will not only analyze the tangible pieces of the project such as the electrical components, but also all the fees incurred for the plan and design of the project. This includes architect fees, engineering fees, and related costs. The fees and costs are allocated among all components rather than being allocated completely to the building.