Cost Segregation Study

Performing a cost segregation study in conjunction with a 1031 exchange can be a powerful tax planning strategy.

If you as a commercial real estate investor have completed a 1031 exchange and the replacement property you purchased cost more than the property or properties you sold, you may be eligible for substantial state and federal tax savings that you can only obtain through a cost segregation study.

A cost segregation study is a strategic analysis that allows owners of commercial real estate to increase their cash flow by accelerating depreciation-related tax deductions. To do so, the study identifies, segregates and reclassifies property costs currently being depreciated over the typical 39-year depreciable period to shorter depreciable periods of 15, 10, 7 or even 5 years. This means you can enjoy tax deductions right now that you’d otherwise have to wait years to receive. So you’ll not only increase the net value of current tax savings, but also boost your cash flow.

Commercial property owners often view building components as parts of one entire structure and depreciate everything over 39 years. But many expenditures fall into categories with much shorter depreciable lives. For instance, you may be able to define the parking lot as 15-year property, and landscaping and shrubbery for the outside of the building as 10-year property. You could also classify lighting and plumbing fixtures, as well as carpeting used in a new showroom, as seven-year property. And don’t forget items such as electrical and ventilation systems, phone lines, computers and furniture, which can be classifiable as five-year property.

Also, the current Section 179 expensing rules still apply for depreciation if you operate your business as a limited liability company and hold your building in that entity. And perhaps best of all, the fee for the cost segregation study that brings about these savings is generally only 10% to 20% of the resulting increase in cash flow.

A cost segregation study is not a mere depreciation analysis. It calls for far more than just classifying line items from construction invoices. The process requires a team of experts well-versed in accounting regulations and tax laws, as well as engineering and construction principles.

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