Cost Segregation: How It Works And The Technology That Makes This Tax-Planning Strategy Possible - Forbes

As a business owners, we're always searching for creative ways to lower our taxable income. One oft-overlooked option is cost segregation studies (otherwise known as cost segs or cost segregation analysis). Since there are plenty of founders who are probably unaware of how they work, I'll provide an explanation below, along with some insights on how your company can harness new technologies to benefit from this underutilized tax-planning strategy.

What is cost segregation?

The simplest explanation of cost segregation is this: Cost segregation is a strategic tax-planning tool that allows an owner of a building to accelerate the depreciation of certain parts of the building or land over a shorter period of time.

In a cost seg study, a property is broken down into smaller components based on their useful lives. The study looks at components of a property such as:

• The building.

• The land.

• Land improvements.

• Personal property.

This breakdown of components could contain hundreds or even thousands of individual line items depending on the size of the asset. This is why it is important to make sure all your data is in order before you get started! The goal is to uncover assets that can be depreciated on an accelerated basis, and you can only do this if you have sufficient data on the various components of your commercial real estate property.

What components of a building are eligible for accelerated depreciation?

The building itself (the frame and basic structural components) is only eligible for straight-line depreciation. Noncommercial buildings are eligible for straight-line depreciation over 27.5 years. Commercial buildings are depreciated using a straight-line method over 39 years.

Assets that are categorized as tangible personal property -- such as equipment, flooring, fixtures, window treatments and computers, to name a few -- are eligible for an accelerated depreciation schedule of five or seven years. This aligns with the reality of commercial space, where updates are made on a regular basis to deal with the regular wear and tear on a building.

Land improvements include sidewalks, landscaping, parking lots and sprinkler systems. Land improvements have a 15-year accelerated depreciation schedule.

For a deep dive into cost segregation, you can access the IRS’s Audit Techniques Guide (ATG). This guide elaborates on the background (including landmark cases that have influenced the current use of the tax strategy), as well as the most current methodologies the IRS recognizes for asset allocation.

Who can benefit from cost segregation?

Cost segregation is most beneficial for building owners and investors with properties exceeding $500,000.

A cost segregation study can be conducted at any time during the life of a building, whether it is an acquisition, built from the ground up or renovated. However, the greatest benefits occur in the year the property was put into service.

In the event you were unaware of this tax strategy or found that it wasn’t a good fit for you at the time, you can do a look-back study for a property that was placed in service going back as far as January 1, 1987.

Is there any tax planning technology out there that can assist with cost segregation? 

Tax planning is complex. Gone are the days when it can be done by hand. Just like in all other aspects of taxes, there is specialized, easy-to-use software that can help you get started with cost segregation. Here are some helpful tips on how to get started using this technology to assist you with cost segregation:

• First, knowing where you are on income for the year is crucial. To uncover this valuable data, one option is the real estate asset management software.

• There are some helpful online cost segregation savings calculators that you can use for free. These calculators can estimate how much you’ll save on federal income tax so you can determine if it’s worth it to proceed. Simply input the purchase price of the property, your state and federal tax rates, and a few other numbers, and you’ll get information that can help you decide if cost segregation is the right strategy for you.

• Armed with this information, you can reach out to cost segregation consultants who will determine eligible savings for you. Or, you can do it on your own through software such as Titan Echo Cost Segregation Software or the ELB Consulting DIY Cost Segregation tool. These software programs can greatly simplify the process of cost segregation and enable you to do it all in-house if you’re not interested in hiring a specialized cost segregation consultant.

The bottom line

Cost segregation studies are a powerful tax strategy for qualified real estate owners. Here’s why:

• Cost segregation studies can accelerate depreciation to the shortest time possible on all eligible assets, thereby reducing taxable income and improving cash flow.

• This activity frees up cash for use today rather than waiting decades to enjoy the benefit.

• That cash can then be reinvested back into the business for additional growth.

The world of real estate continues to evolve and improve as technology helps owners quickly, easily and profitably manage their portfolios. Cost segregation could be just what you’re looking for as you plan for next year’s taxes.

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