Cost segregation is a unique tool to minimize tax burdens while maximizing depreciation deductions. It is particularly beneficial for both small and big businesses. Most people have not been paying attention to it because they do not know how it works.
If your business is planning to purchase, build, or renovate a building, you should take a keen interest in this article. We will explore everything you need to know about cost segregation studies and how it can benefit your business – big or small.
What Is Cost Segregation?
Cost segregation analysis is a comprehensive study that reviews each property component and segments them into different categories. As a result, you are provided a window of opportunity to benefit from depreciation over a shorter period.
Most importantly, your business’ property goes well beyond the physical edifice. For example, this includes the land where the property is built, the natural vegetation, fencing, carpeting, plumbing, fittings, accessories, and many more.
These components have individual depreciation ranging from 5 to 15 years. But they are usually roped together into the building construction or acquisition. More so, you can write off part of the building’s lifespan of 27.5 years (rental) and 39 years (commercial), respectively.
Cost segregation amends that by separating each piece that makes up the puzzle.
How Does Cost Segregation Work?
Cost segregation identifies property components that can be depreciated in a couple of years and writes them off using bonus depreciation. As a result, you would experience reduced taxable income and enhanced cash flow.
It is an analysis that reviews all available records and presents findings in a comprehensive document.
Interest in cost segregation increased after the Coronavirus Aid, Relief, and Economic Security (CARES Act) passed, which increased bonus depreciation to 100% throughout 2022. Additionally, the Tax Cuts and Jobs Act (TCJA) introduces properties acquired.
In the CARES Act, there is a new provision for qualified improvement property (QIP) to have a 15-year class life – which as a result, made it eligible for 100% bonus depreciation. Similarly, in the TCJA Act, real estate owners and investors can deduct up to 100% on 5, 7, and 15-year property – all in the first year.
What is The Best Time to Get a Cost Segregation Analysis?
The best time to carry out a cost segregation analysis is the year in which the building is purchased, constructed, remodeled, renovated, or expanded. However, if the building was acquired years ago, you can benefit.
IRS tax rules favor tweaking your current accounting methods to identify these assets that have depreciated. Thus, you can claim all previous depreciation from the current year of the analysis without amending your past tax returns.
To accomplish this, you need to hire a team comprised of engineers and tax advisors to segment the components of your building ascertain how much they cost and their depreciation. Cost segregation takes around 30 t0 60 days to complete.
Benefits of Cost Segregation Analysis
There are several benefits for small and large businesses, which includes the following:
Smooth Future Depreciation Capturing
One of the unique benefits of doing this analysis is updating annual tax reports and reducing future tax payments and other upfront fees.
Cost segregation allows your business to identify the value of unused components in your building that you can sell off.
Shorter Depreciation Time
This analysis also helps your business to separate personal assets from the building. This study allows your business to ascertain the depreciation period between 15 years for land improvements and 5 to 7 years for individual assets.
Under the CARES and TCJA Acts, you can write them off for 100% bonus depreciation.
Increment in Cash Flow
When your business disburses fewer tax deductions, it will have improved cash flow you can reinvest into the business’ development.
Which Items Are Classified Under Cost Segregation Analysis?
The following are classified under cash segregation analysis of real estate:
- Parking lots
- Appliances, etc.
What Type of Real Estate Property Qualify for Cost Segregation Analysis?
The following properties that qualify for cost segregation analysis can include:
- Apartment buildings
- Grocery stores
- R&D centers
- Manufacturing warehouses
- Office buildings
- Auto dealerships, etc.
Documents Needed for a Cost Segregation Analysis
You should have the following documents in place for an analysis.
- Change orders
- Construction contract
- Budget for the construction
- Architectural drawings and designs
- Contractor’s payment
- Closing statements
- Site survey
- Appraisal and tenant list
However, you can still run an analysis even if you do not have any of the documents above.
Looking at everything we have discussed, cost segregation analysis is suitable for small and large businesses. In short, you should take advantage and reclaim past depreciation deductions and improve your cash flow.
Expense To Profit is dedicated to improving your business operations by reducing costs and maximizing profits. Reach out to us today to discuss how your business can benefit from cost segregation in addition to other cost reducing.
Published by Marc Freedman
Marc currently serves as our Chief Cost Evaluator, expertly advising our client management team on how to help you successfully achieve your business and financial growth goals. A respected mentor to all he consults with, he is an avid collaborator and contributor to the spend consultant community, guiding thought leaders to formulate, design, and install the best operational solutions available to their clients.