Cost segregation allows a taxpayer to separately depreciate components unrelated to a building’s maintenance and operation over shortened depreciation periods. These deductions are computed using an accelerated depreciation method, allowing costs to be recovered more quickly than under the straight-line method.
A cost segregation study should be conducted by a qualified engineer, as only engineering-based studies will likely withstand IRS scrutiny. However, as property is reclassified as five-, seven- and 15-year personal property, it may then qualify for 30 percent and 50 percent bonus depreciation under the 2001 and 2003 tax acts. Your CPA should work closely with the cost segregation engineer to ensure you take advantage of the tax deductions that you qualify for.
In general, residential rental real estate properties depreciate over 27.5 years and commercial real estate properties depreciate over 39 years. A cost segregation study segregates and reclassifies elements as personal property; therefore, a portion of a building’s cost can be depreciated over much shorter periods — usually ﬁve or seven years. It would be impossible to list them all, but common examples include molding, millwork and other decorative elements; carpeting and wall coverings; partitions; window treatments; counters, cabinets and shelving; special lighting, specialized machinery and equipment, and the costs of plumbing and electrical allocable to such equipment.
In addition, certain land improvements located outside a building may be depreciated over 15 years. Land improvements include items such as landscaping, fences, sidewalks, curbs, parking lots, lighting, utilities, signs, swimming pools, tennis courts and playgrounds.
When these nonstructural components are reclassiﬁed as personal property, substantial savings may be realized, depending on the size of the building and the nature of the personal property. As much as 50 percent of a building’s components may be reclassiﬁed into a shorter recovery period.
For example, let’s consider a $900,000 building purchased October 1. Using the straight-line method, the owners can depreciate the property over 39 years, with an average annual depreciation of $23,076. In this case, a cost segregation study is able to reclassify $110,000 as land improvements, depreciable over 15 years, and $140,000 as personal property, depreciable over five years. Assuming a 35 percent federal and 6 percent Georgia income tax rate, the business owner should be able to increase their depreciation by $140,136 over five years, resulting in more than $57,000 in deferred taxes, which could increase the company’s cash flow.
Another advantage is a cost segregation study may provide easier write-offs for building components that need to be replaced. Whether under construction, being remodeled or purchased, there are valuable tax deductions hidden in your property.
William G. Lako Jr., CFP, is an executive in residence at Kennesaw State University’s Coles College of Business and a principal at Henssler Financial. Lako is a certified financial planner.The Marietta Daily Journal will periodically publish columns from KSU business faculty.