Cost Segregation Study
Jul 16, 2015
A cost segregation is an engineered study which segregates property into appropriate Federal Income Tax Depreciation classifications while maximizing depreciation expense. This enables you to accelerate depreciation on components of the aforementioned real property from 39 or 27.5 years to 5, 7, or 15 years. If you have purchased, constructed, remodeled, or otherwise acquired real estate after January 1, 1986, you qualify for this service.
According to the Journal of Accountancy, “the major advantage of cost segregation is not necessarily that it will produce more depreciation deductions. Instead, due to the time value of money, the advantage of these front-loaded deductions will be quantifiably greater than had the deductions been spread over longer periods of time using slower depreciation methods.” Cost segregation studies are an excellent way to increase your tax savings and generate cash flow related to real estate assets.
An engineered-based cost segregation study is preferred by the IRS. A wide range of building components, such as electrical installations, plumbing, mechanical components, and finishes can be identified and reclassified based on an engineer’s recommendations. Substantial savings can be identified with an engineered-based study: “In general, it is the most methodical and accurate approach, relying on solid documentation and minimal estimation.” In addition, the involvement of an accountant offers significant tax law knowledge and experience.Combined, these two experts will ensure a maximum depreciation deduction benefits are realized.
The following example is provided to illustrate the benefits that can be derived from cost segregation:
A newly constructed commercial building valued at $1,000,000 would normally be depreciable over 39 years without a cost segregation study. However, an engineered study would reallocate components of this real property into accelerated lives of 5, 7, or 15 years. Let’s assume in this example that 25% of the total cost was allocated to both 5 and 7 year property, 10% was allocated to 15 year property and the remaining 65% remained allocated to 39 year property.
Without the cost segregation, estimated total allowable depreciation amounts to approximately $14,000 in year 1 and $168,000 after 7 years. In contrast, the reallocation due to cost segregation may generate total allowable depreciation of approximately $204,000 in year 1 and $428,000 after 7 years.
The increased allowable depreciation produces significant tax savings and an immediate avenue for increased cash flow. In this example, gross tax savings for year 1 amounts to $85,500. Even after 7 years, the gap in allowable deductions remains considerable with $414,000 of increased accumulated depreciation that would have been otherwise deferred to later years.
Please note that the above example is for illustrative purposes only and does not reflect present value calculations or the results of state, local, and the alternative minimum tax.
William Vaughan Company offers cost segregation studies based upon guidance provided in the Internal Revenue Code, court cases, and construction cost manuals. Furthermore, the cost segregation analysis generated by William Vaughan Company’s professional team is tailored to fully comply with the IRS Cost Segregation Audit Techniques Guide. Please contact David A. Hammack, CPA/PFS or Nathan M. Bernath, CPA at 419-891-1040 with any questions or to schedule your FREE analysis.
By: Nate Bernath, CPA
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