What is Cost Segregation?
Cost Segregation is a tax deferral strategy for commercial real estate owners. It allows them to utilize accelerated depreciation deductions to create more cash flow. The aim of a cost segregation study is to identify the personal property components of a building that can be depreciated and at an accelerated rate relative to the rate of applicable structures. A properly conducted and documented strategy can unlock a dramatic source of tax deductions all in one taxable year, which can be used to offset income.
How is Cost Segregation used?
In a typical commercial real estate transaction, the buyer acquires land along with several other assets, buildings, and fixtures for a single purchase price. The land itself cannot wear out and lose value, in short it can’t be depreciated. Buildings work differently. A cost segregation analysis categorizes each component of real property improvements by class and recovery period. The goal is to segregate personal property from the building itself. This allows the taxpayer to take advantage of the shorter recovery periods for personal property, thus larger tax deductions.
How to meet the Requirements?
To be eligible for depreciation an asset must meet four requirements, set out in IRS Publication 946:
- The asset must be property owned by the taxpayer.
- It must be used by the taxpayer’s business or income-producing activity.
- It must have a determinable useful life.
- It must be expected to last more than one year.
As You might imagine, the scope of assets subject to depreciation is quite broad. Businesses are often surprised by how specific a well-executed cost segregation analysis gets, and how many distinct assets can be identified in and around a commercial building.
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