The benefits of using cost segregation in estate planning
Estate planning for inherited assets often involves managing the step-up in basis for real estate, which affects both estate and income taxes. When a property is inherited, its tax basis is adjusted to its fair market value (FMV) on the date of death, meaning any appreciation during the decedent’s lifetime is not taxed.
Tax professionals typically focus on how this stepped-up basis affects the estate’s taxes and the beneficiary’s future tax liability. However, they might overlook the opportunity to adjust the original tax basis for real estate recorded on the decedent’s tax depreciation schedule before their death. This adjustment can be made even after death, but must be done before filing the decedent’s final income tax return.
A cost-segregation study of the building’s pre-stepped-up basis can be particularly effective. This study accelerates depreciation deductions, potentially eliminating taxes owed on the final return and reducing the building’s pre-stepped-up basis. Despite the reset of the basis to FMV at death, cost-segregation can still offer tax benefits without recapture taxes upon the sale of the property.
Cost-segregation studies accelerate deductions over shorter periods compared to the extended depreciation periods for buildings, providing a significant current-year deduction. However, if the property is sold soon after the study (typically within five years), the benefits of accelerated deductions may be recaptured. The study must be completed and implemented before the extended due date of the decedent’s final return to be effective.