Cost Segregation Study
Cost segregation is a fundamental tax planning method that gives realty owners considerable savings by enhancing cash flows via accelerated depreciation deductions. Let’s find out more about the topic.
What is a Cost Segregation Study?
A Cost Segregation Study is a tax planning tool that allows commercial property owners to reclassify building components as personal property, which can then be depreciated over a shorter recovery period than the building itself. This can result in substantial tax savings for the property owner. For example IRS allows you to depreciate a residential property over 27.5 years and a commercial property over 39 years. But reclassifying building components can allow you to depreciate many components over 5 or 15 years, thereby increasing the depreciation early in the property ownership.
Cost segregation is particularly beneficial for new commercial buildings, building expansions, or remodels, as it allows property owners to recover their investment in the building faster. The process involves a detailed analysis of all the components of the building to determine their proper classification for tax purposes. This includes identifying building components that can be reclassified as personal property, such as lighting fixtures, carpets, wall coverings, and kitchen equipment.
What is Depreciation?
Depreciation is allocating the cost of a tangible asset over its useful life. It is used to reflect the decrease in value of an asset due to wear and tear, obsolescence, or any other factors that may reduce its value. Depreciation is essential for businesses and individuals as it affects their financial statements and tax obligations.
For tax purposes, depreciation is used to determine the amount of an asset’s cost that can be written off as an expense each year, which reduces the taxable income. The tax law provides guidelines on the useful life of assets and the methods of calculating depreciation.
Several methods of calculating depreciation include straight-line, declining balance, and the sum of the years’ digits. The method chosen depends on the asset type and expected use. For example, the straight-line method is commonly used for real estate, while the declining balance method is used for assets that are expected to decrease in value rapidly over time.
Who will benefit from Cost segregation?
Cost Segregation Studies can benefit a variety of commercial property owners, including:
Businesses that own commercial real estate: Companies that own commercial buildings can use cost segregation to reduce their taxable income and improve their cash flow.
Real estate investors: Investors who own commercial properties can take advantage of cost segregation to maximize their tax savings and improve their return on investment.
There are couple of specific cases, where additional depreciation can really help real estate investors reduce their tax liability. One such case is where you have income from other real estate that’s bigger than the depreciation allowed on the property. If you have two properties, then the depreciation you get on one property can be used to offset income of other property as well! This means getting additional depreciation can help you reduce your taxable real estate income.
It’s important to note that depreciation cannot be used to offset your W-2 income. This is only allowed in case you are married and filing your tax return jointly and one of the spouses is a full-time real estate investor. I am not a Tax expert and this should not be considered as a tax advice. It’s best to consult a CPA to understand intricacies involved in the tax matters. Alternatively, you can also read The Book on Advanced Tax Strategies.
Limits for Bonus Depreciation
In 2023, a business can claim the maximum amount of bonus depreciation is 80%. Bonus depreciation is the accelerated depreciation you can claim through Cost Segregation Study.
The Tax Cuts and Jobs Act of 2017 allowed taking upto 100% bonus depreciation of the commercial properties. But the 100% limits start phasing down from 2023. Hence the lower limit for 2023. Every year thereafter the limit will decrease by 20%. In 2026, the amount of bonus depreciation allowed will be 20%.
In conclusion, the amount of bonus depreciation a business can claim is subject to limits and can change yearly based on tax laws and legislation. Companies should consult with a tax advisor or accountant to determine their eligibility for bonus depreciation and the amount they can claim in 2023.
What IRS Form is used to show Depreciation?
In the case of real estate syndication, the depreciation from the property is typically reported on Schedule K-1. This form says a partner’s share of income, deductions, credits, and other items from a partnership or limited liability company (LLC) taxed as a partnership.
In the case of a cost segregation study, the reallocation of building components as personal property may result in a more considerable amount of depreciation being reported on Schedule K-1, which can significantly impact the partner’s taxable income.
It’s important to note that syndication partners may also have to report this depreciation on their tax returns, depending on their tax situation. As such, partners should consult with a tax advisor or accountant to determine the impact of the depreciation reported on Schedule K-1 on their tax returns.
In conclusion, a Cost Segregation Study is a valuable tool for commercial property owners looking to reduce their tax liability and improve their cash flow. Property owners can take advantage of substantial tax savings and improved financial performance by reclassifying building components as personal property and depreciating them over a shorter recovery period.