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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.

Below you will see an example of a cost segregation study Baker Tilly recently completed for one of our clients. In this example, total present value project federal tax benefit is $82,000 or 4% of the cost of the project! Note, the benefit could be limited by other provisions of the tax code, including the excess business loss limitation in IRC section 461(l).

Proposed benefits of cost segregation study

Conclusion

Proper cost segregation requires expertise in accounting, appraisal, tax law, valuation, engineering, architecture, real estate and construction cost estimating. Baker Tilly has the depth of expertise needed to help you take advantage of this opportunity. A cost segregation study can be completed on past or current transactions. Therefore, if you feel you missed an opportunity in a previous year when you purchased, built or renovated your practice, please reach out to one of our dental experts today.

For more information on this topic, or to learn how Baker Tilly specialists can help, contact our team.

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.

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