What is a cost segregation study and when does it make sense?

Posted on November 24, 2021

We had Lester Cook from KBKG on our Podcast to discuss cost segregation studies and how they work. This is a more advanced strategy for those that have buildings purchases, improvements, construction, etc.

What is Cost Segregation?

Cost Segregation is a commonly used strategic tax planning tool that allows companies and individuals who have constructed, purchased, expanded or remodeled any kind of real estate to increase cash flow by accelerating depreciation deductions and deferring federal and state income taxes.

What is a Cost Segregation Study & How Does it Work?

When a property is purchased, not only does it include a building structure, but it also includes all of its interior and exterior components. On average, 20% to 40% of those components fall into tax categories that can be written off much quicker than the building structure.

A Cost Segregation study dissects the construction cost or purchase price of the property that would otherwise be depreciated over 27 ½ or 39 years. The primary goal of a Cost Segregation study is to identify all property-related costs that can be depreciated over 5, 7 and 15 years. For example, certain electrical outlets that are dedicated to equipment such as appliances or computers should be depreciated over 5 years.

Our partner goes beyond a traditional Cost Segregation study and will also separate all of the different building structural components (such as the roof, windows or HVAC units) so when they are replaced, a loss deduction can be claimed on them. For leased property, we also separate tenant leasehold improvements.

What is Involved in a Cost Segregation Study?

A quality Cost Segregation study evaluates all information, including available records, inspections, and interviews, and presents the findings in a clear, well-documented format.

Our process for conducting a detailed Cost Segregation includes a review of any available cost detail for the property, a review of any available blue prints and a physical inspection of the property. If none of this information is available, a Cost Segregation study can still be performed by estimating component values on site.

When should a Cost Segregation study be conducted?

A Cost Segregation study can be completed any time after the purchase, remodel or construction of a property. However, the optimum time for a study for new owners is during the year a building is constructed, purchased or remodeled. For investors who are in the planning phases of construction or remodeling, the best time to consider a Cost Segregation study is before the infrastructure of the building is set. Our partner offers a free preliminary analysis that can help determine the right timing and strategy for any investor.

What are the Benefits of Cost Segregation?

Many business owners are surprised to learn of the compelling tax savings a cost segregation study offers. Below is a list of three of the most prominent benefits.

  1. Cash Flow
    • Generates immediate increase in cash flow through accelerated depreciation tax deduction.
  2. Write Off
    • Quantifies property’s major components and leasehold improvements so they can be written off when replaced or renovated
  3. Review
    • Provides an independent third-party analysis that will withstand IRS review.

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