Cost segregation is a strategic tax planning tool that commercial property owners can leverage to accelerate depreciation deductions, thereby reducing their taxable income and enhancing cash flow. Despite its significant benefits, this method is often underutilized due to a lack of awareness and the complexity involved in conducting a detailed analysis. By engaging with cost segregation specialists, property owners can unlock substantial tax savings and optimize their investment returns.
Cost segregation is a fiscal optimization strategy that involves identifying and reclassifying personal property assets to shorten the depreciation time for taxation purposes, which can result in substantial tax savings for commercial property owners. This method is supported by the IRS and endorsed by the American Institute of Certified Public Accountants (AICPA) as a legitimate tax planning technique.
While tax professionals such as CPAs and tax attorneys are adept at navigating the tax code, the intricacies of cost segregation often require the expertise of a specialist. These professionals conduct comprehensive studies to identify property components that can be depreciated over shorter periods—typically 5, 7, or 15 years, rather than the standard 27.5 or 39 years. This accelerated depreciation can lead to significant tax deductions and improved cash flow for property owners.
A cost segregation study involves several key steps:
It is generally advisable to conduct a cost segregation study in the year a property is purchased or constructed. However, property owners who have acquired or built property after 1986 can also benefit from retroactive cost segregation studies, allowing them to catch up on missed depreciation without amending past tax returns.
The potential tax savings from cost segregation can be substantial. For example, O'Connor & Associates, a national real estate consulting firm, has reported first-year tax savings ranging from $35,500 to $160,000 for office properties and from $19,240 to $96,200 for apartment complexes, depending on the property size. These savings can result in a payback ratio of 4:1 for the first year and 20:1 over five years.
Commercial properties with an improvement basis of $500,000 or more are prime candidates for cost segregation. Properties with significant site improvements, such as landscaping and parking, often yield the most favorable results. This strategy is effective for various property types, including apartments, offices, retail spaces, industrial facilities, self-storage units, and special-use properties.
Despite its advantages, cost segregation is employed only about 5% to 10% of the time. This underutilization may be due to the specialized knowledge required to perform the studies, which falls outside the typical scope of tax preparation services. However, as awareness grows and more professionals recommend cost segregation, its adoption is likely to increase.
To maximize the benefits of cost segregation, it is crucial for tax preparation experts to be involved throughout the process. This ensures that the study is accurately integrated into the overall tax strategy and that the property owner reaps the full tax savings.
Cost segregation is a powerful tool for commercial property owners seeking to reduce their tax burden and improve cash flow. By working with specialized cost segregation professionals, property owners can ensure that they are taking full advantage of this tax strategy and making informed decisions about their property investments.
For more information on cost segregation and its benefits, property owners can reach out to experts like Larry Brewster at 1-800-856-REAL(7325).
Patrick O'Connor, MAI, is the president of O'Connor & Associates, a firm that has been providing a wide array of real estate consulting services, including cost segregation, since 1974. O'Connor is recognized as a reputable source for real estate trends and insights.
O'Connor & Associates is a national provider of commercial property real estate consulting services, offering expertise in areas such as appraisals, tax reduction, market research, and more.
