| More tax deductions means tax | | | | Cost |
| reductionImportant Commentary for Owners of | | | | 3???????? |
| Real EstateBy Patrick O’Connor, | | | | Annual |
| MAIDepreciate Property Improvements | | | | Depreciation$0$74,935$1,348$33,013$115,210 |
| Correctly...and Pay Less Federal Income TaxMost | | | | Year 1 depreciation with cost segregation |
| commercial real estate owners are paying excess | | | | $224,506 |
| federal income taxes because they are not | | | | Less annual depreciation without cost |
| depreciating their property as quickly as they | | | | segregationAdditional year 1 depreciation |
| should. A cost segregation study allows property | | | | 137,75686,750 |
| owners to both defer and reduce federal income | | | | Year 1 tax savings based upon 35% marginal tax |
| taxes. Cost segregation increases depreciation (a | | | | rate |
| non-cash deduction) for commercial real estate | | | | $30,362Who Benefits from a Cost Segregation |
| owners. When properly performed by an | | | | StudyIf you own real estate and pay federal |
| appraiser with expertise in cost segregation, this is | | | | income taxes or expect to during the ownership |
| a conservative tax planning tool which reduces | | | | period for the property, you will benefit from the |
| federal income taxes by properly allocating the | | | | results of a cost segregation study. This is true |
| cost basis between land, 5-year, 7-year, 15-year, | | | | whether the owner of the real estate is a |
| 27.5-year and 39-year property. (Long-life | | | | corporation, limited partnership or limited liability |
| depreciation is 27.5 years for residential rental | | | | corporation. For syndicators, a cost segregation |
| properties and 39 years for commercial | | | | study is appropriate if limited partners will receive |
| properties. Carpet and vinyl tile are typical 5-year | | | | material net taxable income during the holding |
| items. Site improvements such as landscaping and | | | | period even if the general partner does not |
| paving are 15-year items.)Depreciation is an | | | | currently pay federal income taxes. The cost |
| important non-cash tax deduction. By increasing | | | | segregation study will increase depreciation shield, |
| tax deductions, commercial property owners | | | | thereby decreasing and deferring federal income |
| affect federal income tax reduction. (Depreciation | | | | taxes for the investors.Decreasing and Deferring |
| indirectly reduces income taxes by reducing | | | | Federal TaxesSince a cost segregation study |
| taxable income. Income tax credits directly reduce | | | | decreases and defers federal income taxes, |
| income taxes.) The increase in tax write-offs | | | | let’s review the long-term impact of this |
| generates such a large tax cut that some wonder | | | | deferral. When the property is sold, capital gains |
| if it is a tax shelter or tax evasion scheme. It is | | | | tax will be due if the owner does not enter into a |
| not. Cost segregation is an IRS-guided process | | | | 1031 exchange. However, capital gains tax rates |
| used to increase tax deductions during the tax | | | | are typically 15% for high net worth individuals, |
| preparation process. The IRS has provided a | | | | while the ordinary income tax rate is 35%. In |
| detailed explanation of the items that qualify for | | | | addition, the deferral during the ownership period |
| short-life depreciation and acceptable | | | | has material benefits because of the time value |
| methodologies for performing a cost segregation | | | | of money. All investors would much rather pay a |
| study. Cost segregation studies performed by | | | | 15% tax rate when an asset is sold as opposed |
| appraisers in compliance with the IRS's Audit | | | | to paying a 35% tax rate today.When Should You |
| Techniques Guide are unlikely to be challenged in | | | | Obtain A Cost Segregation StudyThe best time |
| an audit. Commercial real estate owners seeking | | | | to obtain a cost segregation study is when you |
| tax advice and tax relief can benefit from | | | | build or purchase a property. Documentation is |
| reviewing the tax relief available from cost | | | | most readily available for performing a study and |
| segregation.Cost Segregation Study Benefits | | | | a contemporaneous property inspection can be |
| include Tax Deductions and Tax ReductionBenefits | | | | performed to best document results. However, |
| of a cost segregation study are substantial, | | | | there are options to perform a cost segregation |
| immediate and enduring. Year 1 federal income | | | | study for property which has been developed or |
| tax savings are typically at least two times the | | | | purchased previously.Elements of Preparing a Cost |
| cost of a cost segregation study. In many cases | | | | Segregation StudyThe appraiser starts by |
| they are five to fifty times the cost of the study. | | | | gathering documents from the property owner |
| The present value of federal income tax savings | | | | and performing a site visit. As necessary, |
| for a property held for ten years are typically at | | | | depending on the special-use property found |
| least ten times the cost of the study. In many | | | | during the site visit, the appraiser would confer |
| cases, the present value of tax savings as much | | | | with tax counsel and review relevant tax court |
| as 30 to 50 times the cost of the report. The | | | | decisions. For newly constructed properties, most |
| cost segregation study is only required once. Its | | | | of the information on actual costs can be obtained |
| cost is not recurring, but the benefits are | | | | from construction draws or invoices from |
| recurring during the term of property ownership. | | | | contractors. For existing properties, the appraiser |
| A cost segregation study can also materially | | | | performs a quantity take-off for 5-year, 7-year, |
| reduce local property taxes by separating real and | | | | and 15-year property and estimates replacement |
| personal property for newly constructed | | | | cost using recognized sources. The appraiser then |
| properties.Detailed ExamplePreparing a cost | | | | values land, 5-year, 7- year, 15-year, 27.5-year |
| segregation study requires only a limited time | | | | and 39-year property based upon inspection, |
| commitment from the owner, perhaps 10 to 15 | | | | analysis and IRS regulations and court rulings.Does |
| minutes. This limited commitment of time results | | | | this only apply to large owners?Both large and |
| in substantial federal income tax savings, which | | | | small owners of income property or |
| are both conservative in approach and well | | | | owner-occupied commercial property can benefit |
| documented. Some owners believe their | | | | from a cost segregation study. Commercial |
| accountant is properly segregating components | | | | properties with a cost basis of at least $200,000 |
| into the proper classifications. Many accountants | | | | will likely see a material benefit in excess of the |
| and tax lawyers cannot thoroughly research this | | | | cost from a cost segregation study. In fact, |
| highly specialized field to understand the myriad | | | | owners of single-family rental homes can probably |
| number of items which can be segregated and | | | | achieve worthwhile benefits by obtaining a cost |
| are inadvertently overstating their client’s | | | | segregation study.Qualifications to Consider when |
| income tax liability. Furthermore, not obtaining a | | | | ordering a Cost Segregation ReportThe ability to |
| cost segregation study increases exposure in | | | | value land and real property are critical elements |
| case of an audit since there is no clear audit trail. | | | | when engaging a tax reduction expert to perform |
| A cost segregation study prepared by an | | | | a cost segregation study. In addition, it is essential |
| appraiser with expertise in land valuation, | | | | they have a detailed understanding of rules for |
| construction costs and market value clearly | | | | classifying 5-year, 7-year, 15-year, 27.5-year and |
| documents each of these items. Further, a cost | | | | 39-year property. The ability to justifiably increase |
| segregation expert can almost certainly sharply | | | | short-life depreciation materially increases the |
| increase allowable depreciation.Following is a | | | | benefits of a cost segregation study. While most |
| summary of the results of a cost segregation | | | | accounting professionals have a rudimentary |
| study based upon a recent assignment: Office | | | | understanding of the 5-year, 7-year and 15-year |
| BuildingCost Segregation Example | | | | property classifications, few have a detailed |
| Total costLandDepreciable basis???????? | | | | understanding of this highly specialized niche. Be |
| $6,650,000$1,277,500$5,372,500Annual | | | | certain the report provider has scrutinized both |
| depreciation (using 39-year straight line) | | | | the federal income tax code and the meaningful |
| $137,756Accurate Cost Allocation and Depreciation | | | | tax court cases to allow you to maximize your |
| after Cost Segregation Study | | | | depreciation and minimize your federal income tax |
| Land5-year property7-year property15-year | | | | liability. |
| property39-year property???????? | | | | |