use cost segregation to your advantage

Use Cost Segregation To Your Advantage

Is Cost Segregation Right For You?

In our previous article entitled “Strategies to Minimize Tax Liability for Business Owners” we talked briefly about the advantages of using Cost Segregation to accelerate depreciation on certain portions of both residential, and commercial real property. In this article, we’ll take a look at how, and why it may work for you. Additionally, we will share what you need to do to take advantage of the potential benefits.

As a reminder, Cost Segregation is a means by which owners of property can break out certain aspects of a building, and treat them like personal property for depreciation purposes. This allows you to depreciate a portion of your commercial property over 5, 7, or 15 years, rather than the standard 39 for commercial, or 27.5 for residential.

While certain aspects, like landscaping are fairly simple to document and segregate, you’d miss out on a number of opportunities to take advantage of all available accelerated deductions if you didn’t dig a little deeper. That’s where hiring a construction engineer who is a cost segregation specialist can be well worth the investment.

When to Hire a Professional

A cost segregation specialist can differentiate between elements of the building which are defined as “dedicated, decorative, or removable” versus what’s considered “necessary and ordinary for operation and maintenance of the building”. Assets included in the building cost which may be treated as personal property for depreciation purposes may include:

  • Carpeting and flooring
  • Bathroom fixtures
  • Dedicated cooling systems for machinery
  • Electrical fixtures and lighting
  • Decorative finishes

If you spent more than $750,000 to purchase, or remodel a building since 1987; which for rental and other commercial property is easy to do, HKMP can help you engage a specialist to perform a detailed study to identify components in your building qualifying for cost segregation, and who will provide supporting documentation for your allocations. This can be extremely insightful if you acquired the property.

A cost-segregation specialist will analyze architectural drawings, mechanical and electrical plans, and other blueprints to break out those components eligible for treatment as personal property from those which are structural components of the building. As part of their analysis, they’ll also identify, and allocate things like architecture and engineering fees, and other indirect costs to each element.

Take Full Advantage of TCIA Changes

The Tax Cuts and Jobs Act of 2017 (TCIA) made it even more attractive to identify assets which qualify for Cost Segregation. TCIA increases bonus depreciation on qualifying assets from 50% to 100%. It also allows you to retroactively utilize cost segregation on previously owned properties acquired after September 27, 2017. Prior tax law only applied to new construction, and remodels.

Before 1996, retroactive savings on property added since 1987 had to be realized over 4 years. However, in 1996, the law changed. Thus allowing cost savings to be realized all at once, upon completion of the cost segregation report. Until TCIA was enacted, it only applied to new construction. Taking advantage of Cost Segregation now allows you to claim retroactive deductions for catch-up depreciation on older buildings acquired since September 27, 2017 which didn’t qualify for cost segregation prior to the enactment of TCIA. Additionally, you can claim all the savings in one tax year.

Weigh the Costs and Benefits

By utilizing your cost-segregation specialist’s report, HKMP can ensure you take advantage of every opportunity to reduce your tax liability by adjusting the timing on your depreciable assets.  Advantages include:

  • Increased cash flow in years when costs are higher
  • Revisiting properties purchased used which were previously ineligible for cost segregation
  • Identifying opportunities to take advantage of catch-up depreciation
  • Possible reduction to real estate taxes by shifting costs away from real property
  • Potential increase in deductions for sales and use tax
  • Documentation of your re-allocations in the event of IRS inquiries

Please keep in mind, when you’re re-allocating assets you’ve depreciated in prior years, you could create a liability for recaptured depreciation. This could trigger understatement penalties, especially if you’re overly aggressive in your use of cost segregation. Also, cost segregation reports do have a cost. Therefore, it’s a good idea to weigh the potential benefits before any study is done.

HKMP can help weigh the costs and benefits of reallocating assets identified in your cost segregation report. Allowing you to make informed and intelligent decisions, and reallocate costs for the best possible outcome.