Cost Segregation in Real Estate

A How-To Guide for Taxpayers and Tax Professionals

Do you have questions about cost segregation in real estate? We’ve got answers. And if you’d rather speak directly with one of our tax experts, we’re here to talk, anytime.  

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Real Estate Cost Segregation Study

Real Estate Cost Segregation Study Basics

What is Cost Segregation in Real Estate?

Any given property contains a multitude of different assets, and each of them may be expected to have a different useful life. For example, you can confidently expect ceramic flooring to last a lot longer than say, carpet tile. Tax law provides guidance that can indicate how long different assets might last, using the Modified Asset Cost Recovery System (MACRS). The default MACRS class-life for most capital assets is 39 years, or 27.5 years for assets in a multifamily property. That means that if no cost segregation study is performed, assets will typically be depreciated over 39 years for commercial property or 27.5 years for residential. Now that makes sense for ceramic flooring, but not for carpet tile. Why should carpet tile just sit on the books, being depreciated over 39 long years?   

In a real estate cost segregation study, engineers identify and quantify building assets, and then assign each asset a cost. These costs are then segregatedinto different categories according to their depreciable asset class lives. Base building or “shell” assets remain 39-year assets, but many assets can be moved into shorter-lived class lives:    

  • 5-Year Assets: carpet tile, counters, break room sinks, cabinetry and decorative moldings, specialty lighting, dedicated outlets, fire extinguishers and more   
  • 7-Year Assets: office furniture   
  • 15-Year Assets: land improvements like drainage pipes, parking lots, landscaping, outdoor swimming pools, protective bollards, sidewalks, and more  

By segregating these assets into shorter-lived categories, they can be depreciated more quickly, resulting in tax savings and increased cash flow. 

How Does Real Estate Cost Segregation Benefit Investors?

Real estate cost segregation is a strategic planning tool that decreases tax burden while increasing cash flow. By accelerating depreciation deductions, you take advantage of the time value of money. Deductions taken today are much more valuable than deductions taken in the future. The resulting increased cash flow can be reinvested for further gains.  

A real estate cost segregation study is also the key to a variety of additional tax savings strategies. Bonus depreciation permits the additional write-off of an eligible asset’s value in addition to standard depreciation. Cost segregation also provides the data required to perform other tax strategies, including Unit of Property (UoP), Tangible Property Analysis Consulting (TPA), and Energy-Efficiency Studies. 

Can a Cost Segregation Study of Real Estate be performed on older properties or renovations?

A cost segregation study of real estate can be performed at any time during the real estate life cycle.  

Ideally, it’s best to perform a real estate cost segregation study immediately after a property is placed-in-service, to maximize savings from day one. However, if that was not possible, the IRS allows the benefits from previous years to be claimed using a “look-back” cost segregation study. By reclassifying assets to their correct lives, taxpayers can “catch-up” on all the depreciation they would have gotten had the study been performed on day one. Look-back studies require the use of Form 3115. 

Impending renovations are also an excellent trigger for real estate cost segregation. It might seem counterintuitive to perform a detailed study of assets that you plan to dispose of. Why quantify assets that are on their way out? The answer is simple — if these assets are quantified through a cost segregation study before they are retired, you can use that data to take advantage of a strategy called Partial Asset Disposition (PAD) Elections.  PAD Elections permit a taxpayer to write off the remaining depreciable basis of an asset that was disposed of in the year it was removed. This can be an incredible tax-savings strategy, but requires a complete record of the assets in question. 

Is a Cost Segregation Study for Real Estate worth the investment? 

A real estate cost segregation study can certainly be “worth it” in terms of return on investment. Cost segregation fees vary, and are generally commensurate with a project’s scope, size, and complexity. The usual return on investment for a cost segregation report is well over 10 to 1. 

What types of properties qualify for a Real Estate Cost Segregation Study 

Properties like office buildings, hotels, and retail spaces often come to mind when people think of cost segregation for real estate, but that’s just the beginning. A cost segregation study can be performed on any type of commercial real estate and many residential rental properties. In fact, some of the hottest property types for cost seg today include: 

Cost segregation can even be performed onnon-profit tenants in otherwise for-profit spaces, a trend we’re seeing quite a bit of lately. 

Are there Specific Property Types that Capstan Tax Focuses on for Real Estate Cost Segregation?

The Capstan team performs cost segregation analyses on all types of real estate. We’re equally comfortable with the everyday – apartment buildings, medical office suites, warehouses – and the exotic – golf courses, water parks, sawmills, etc.  

If you’re dealing with an usual property type, don’t hesitate to contact us 

Related Capstan Resources 

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