Could Your Business Benefit From a Cost Segregation Study?

Acost segregation study is a method of separating real property from land improvements and personal property to accelerate depreciation deductions. Or to put it simply, a cost segregation study can reduce your tax bill and improve your cash flow!

Commercial property is generally depreciated over 39 years, and residential rental property over 27.5 years. Real property is more than just the building itself – it also contains plumbing, fixtures, carpeting, awnings, removable partitions, window treatments, lighting, HVAC systems … you get the idea.

How much tax savings can a cost segregation study provide?

by STACY SMITH

Personal property, such as equipment, machinery, furniture and fixtures, is eligible for depreciation over either five or seven years. Land improvements like landscaping, sidewalks, dumpster enclosures, fences, outdoor lighting and parking lots are depreciable over 15 years. Certain building improvements can also qualify as personal property if their purpose serves a business function over and above the basic structure, such as reinforced flooring that supports heavy manufacturing equipment, enhanced electrical or plumbing required to run specialized equipment, or cooling equipment for a data processing room.

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So rather than depreciating your building and its fixtures together over the life of the building, a cost segregation study allows you to front-load the depreciation on the items that can be split out, reducing your tax liability for those early years.

You can find a sample list comparing different asset lives specific to restaurant fixtures and equipment at www.irs.gov/businesses/cost-segregation-guide-chapter-72industry-specific-guidance-restaurants.

Whether a cost segregation study results in a reduction in your tax obligations depends on your facts and circumstances. But it can be a valuable investment, especially with enhancements to certain depreciationrelated tax breaks. The Tax Cuts and Jobs Act (TCJA) increased limits on Section 179, which allows the entire cost of qualifying equipment to be immediately deducted. The TCJA also expanded 15-year depreciation to include qualified improvement property instead of only qualified leasehold improvement, retail improvement and restaurant property. And it temporarily increased first year bonus depreciation to 100% instead of 50% through 2022.

When should you conduct a cost segregation study?

The best time to initiate a cost segregation study is at the time a building is purchased, constructed or undergoes a remodel. But if that’s not possible, you can conduct a look-back study in a future year. If a later study results in additional depreciation deductions, you won’t have to amend previous tax returns, as those deductions can be claimed on your next tax return.

It doesn’t make sense to conduct a cost segregation study if you don’t intend to hold onto the property for a longer period.

If you acquire a property upon which a cost segregation study has already been done, it’s still a good idea to conduct your own study because your circumstances may be different.

Scan this QR code to find a sample list comparing different asset lives specific to restaurant fixtures and equipment.

You only need to conduct a study once for a particular property unless you make significant improvements after it’s placed into service, such as a building addition or major remodeling project.

Who conducts the study?

We can assist you in determining whether conducting a cost segregation study makes sense for your business. It’s important to work with a qualified service provider with experience in conducting cost segregation studies. This is not a do-it-yourself project! The team can include both accountants and engineers to determine how building components should be classified. The process involves reviewing property records, appraisals, inspections, closing documents, project costs, construction drawings and blueprints and may include an on-site tour of the property.

The service provider will analyze tax law to support the classification of assets used in the study. A cost segregation study is subject to IRS audit, so it’s important to have supporting documentation for the deductions you’re claiming. A properly documented cost segregation study will resolve many IRS questions at the outset.

How much does a cost segregation study cost?

Fees for a study depend on a variety of factors, including the estimated time to conduct the study, the size, location of the property, the type of property, uniqueness of the building, type of business activity and complexity of the taxpayer’s situation.

Is there a downside to conducting a cost segregation analysis?

The two disadvantages are cost and time. The study is likely to cost thousands of dollars, which are hopefully recouped by the tax benefit resulting from the analysis. And it takes time for the service provider to review all the appropriate information, so expect the study to take four to eight weeks.

If you dispose of personal property after the study, you could incur depreciation recapture subject to ordinary income tax rates. And if your tax position is too aggressive, the IRS could assess penalties, which is why it’s important to use a qualified vendor to conduct the study with good backup documentation.

As always, consult your tax adviser.

Every situation is different, so visit with your tax professional to determine whether a cost segregation study makes sense for your business. The benefits can be substantial, so it’s worth considering! n