The Crucial Role Cost Segregation Studies Play in Maximizing Your Tax Savings

The Crucial Role Cost Segregation Studies Play in Maximizing Your Tax Savings

Many commercial property and residential real estate owners could be leaving potential tax savings on the table by not taking advantage of a cost segregation study. This powerful tax planning strategy allows commercial property owners to accelerate depreciation deductions and unlock significant tax savings. This effectively puts money back into a property owner’s pocket now rather than years later.

If you own commercial properties or residential rentals, here’s what you need to know about cost segregation studies to maximize your tax savings:

What is a cost segregation study?

A cost segregation study is simply an analysis of the costs related to a commercial property.

Cost segregation is a game-changer for property owners.

Typically, commercial and residential rental properties are depreciated over long periods— upward of 39 years. When the IRS calculates tax deduction amounts on these properties, they treat the building as a single unit. So, in determining your deduction, the IRS will divide the property purchase price (excluding the land) by 27.5 or 39 years, depending on the property type. As a result, your first-year deduction is equivalent to your deduction in the last year of the depreciation period.

A cost segregation study enables you to reclassify individual building components (e.g., a property’s roofing, flooring, plumbing, windows, lighting fixtures, fencing, etc.) into considerably shorter tax lives.

Property owners can unlock substantial tax savings and increase their cash flow by depreciating these building components over five, seven or 15 years rather than the standard 27.5- or 39-year timeline.

What activities qualify for segregation?

  • New construction
  • Existing structure
  • Expansion
  • Remodeling
  • Renovation
  • Restoration
  • Property placed in business several years ago
  • Step-up in basis

Whether you are dealing with new construction, existing structures, expansions, renovations, remodeling, restoration, expansion or properties placed in business several years ago, you can potentially unlock cost segregation tax savings. These savings also apply to step-up in basis.

A step-up in basis situation presents an opportunity for a cost segregation study. This is a common and unfortunate situation involving the death of a family member who held real estate. In such situations, the decedent’s heir receives a full step-up in basis to the property’s fair market value as of the date of death. A cost-segregation analysis can be performed to leverage the heir’s new stepped-up tax basis.

Another common situation is the purchase of an interest in a real estate partnership with a section 754 election in place. It gets a little convoluted, but let’s break it down. Let’s say a new partner purchases an interest. The outside basis of the new partner’s partnership interest will be equal to the purchase price, and the partnership’s basis in its assets will remain the same.

However, if the partnership has a section 754 election, the new partner can equalize the partnerships inside basis in its assets and the new partners outside basis. Then the new partner can obtain a step-up in basis equal to the difference between the partnerships inside basis in its assets and the new partners outside basis. A cost-segregation analysis can be performed for new partner’s stepped-up basis.

What are the potential tax savings?

You might wonder, “How much can I actually save with a cost segregation study?”

The answer depends on the individual property, but 20-50% of your building could be eligible for accelerated depreciation. While cost segregation can be beneficial for various property types, some show higher potential for savings, including:

  • Office buildings
  • Hotel/Motels
  • Medical offices
  • Multi-dwellings
  • Restaurants
  • Retail stores
  • Shopping malls
  • Warehouses
  • Industrial plants

A standard cost segregation study takes about 90 days, but your taxes will be reduced immediately.

Let RJI CPAs be Your Guide

Cost segregation may sound complex, but RJI CPAs understands the ins and outs of the process.

We combine the expertise of engineering and accounting specialists with in-depth knowledge of the requirements set forth by the IRS for cost segregation studies. This allows our team to deliver results quickly and effectively. We’ll also work with you to maximize the tax benefits and aid in tax planning.

If you want to take control of your tax savings and elevate your real estate investments, contact our team for a complimentary evaluation of how a cost segregation study could improve your cash flow

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