Understanding Cost Segregation Studies & Potential Tax Benefits

Most CFMs know about depreciation and the specialized rules that should be scrutinized to ensure all potential tax deductions are considered. A cost segregation study can help CFMs and property owners accelerate depreciation deductions, resulting in increased tax deductions and thereby increasing cash flow.

This article will present an overview of the cost segregation study process and its potential tax benefits.

Overview

A cost segregation study is a financial and engineering study of new or existing properties or improvements to identify tangible personal property and other improvements that qualify for shorter tax depreciable lives. The study enables acceleration of federal (and sometimes state) income tax depreciation, which can result in federal income tax savings.

Let’s consider an example: A business owner purchases or builds a facility for his or her operation that would be depreciated over 39 years. If a portion of the property can be depreciated quicker, then the owner’s taxes would be lower in the immediate future because of the increased deductions. In the end, the entire cost of the property (except land) is depreciated, but the cost segregation study enables the acceleration by identifying assets that are 5-year, 7-year, or 15-year property.

Let’s quantify the example and assume the commercial property is purchased for $4 million, with 15% representing land; that is, $3.4 million will be depreciated. The cost segregation study determines that $450,000 of the purchase price represents land improvements that can be depreciated over 15 years and another $400,000 represents 5-year property. Thus, $850,000 of the $3.4 million – or 25% – can be depreciated more quickly.

At the end of the 39-year period, the entire $3.4 million is depreciated, but 25% of the depreciation deductions were taken earlier than they would have under the lengthy 39-year schedule.

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