Why a cost segregation study?
A cost segregation study is executed to defer paying income taxes and increase current cash flow through accelerated depreciation of certain cost components of a property.
The overall amount of depreciation does not change but what does change is that certain components of a property are depreciated much faster. In general certain costs are reclassified from 39 or 27.5 years into 15, 7, 5, and 3 years or even expensed in the current year. Without having a cost segregation study completed, a taxpayer is essentially pre-paying their taxes years ahead of when they are required.
Benefits of a Cost Segregation Study
The present value savings is typically anywhere from 1% to 5% or more of the total capitalized cost of the project. This is based on a time value of money concept and includes assumptions for total income tax rates, discount rates, and the amount of time the taxpayer is expected to own the property before selling it.
In general, every dollar reclassified from 39 years to 5 or 7 years produces a present value savings of approximately $0.21 to $0.23. Every dollar reclassified from 39 years to 15 years produces a present value savings of approximately $0.11. The benefit is even higher when certain 5, 7, and 15 year property is eligible for bonus depreciation, depending on when construction was started and when the property was placed in service.
A cost segregation study is applicable to nearly every type of real estate or leasehold improvement in which the property owner can use additional tax deductions. However, cost segregation studies are generally not relevant for not-for-profit entities or governmental entities.
Note, however, that while taking overly aggressive positions within a cost segregation study can yield an initially higher benefit, in the event of an IRS audit the taxpayer must be able to defend those positions and could be liable for fees and penalties – some of which may be very significant. The IRS cautions taxpayers to be sure they have sound documentation and evidence to support the classification of their assets.
If the taxpayer is not planning on holding the property for a reasonable time period and plans on selling quickly, the benefits of a cost segregation study may be reduced or negligible. Using certain assumptions, we also have the ability to calculate the present value savings based on any type of hold period and will review this with the taxpayer before proceeding with the study.
Certain property types benefit much more from the analysis. The greater amount of property reclassified into shorter life, the greater the benefit. As shown in the following chart, the total property reclassified from 27.5/39 year to 15 year and 5/7 year property can vary substantially by the type of property, construction, function, and location.
Reclassification Percentages by Industry
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