Understanding the purpose of a cost segregation study
Property acquired or constructed by taxpayers can be depreciated over its useful life for tax purposes, based on specific IRS guidelines. Different types of property have different useful lives; for instance, commercial buildings are typically depreciated over 39.5 years, while movable partitions and technology assets may have shorter useful lives, often around 5 to 7 years.
Determining the useful life can be complex and often requires a professional engineering study known as a “Cost Segregation Study.” This study allocates the components of a building into different categories with shorter depreciation periods, potentially offering significant tax benefits to the taxpayer. For example, a building acquired for $2,000,000 might be depreciated over 39.5 years without such a study, whereas a cost segregation study could identify $300,000 worth of assets with a shorter 5-year depreciation period, resulting in higher early-year depreciation deductions.
The benefits of a cost segregation study include maximizing early depreciation deductions, which can provide immediate tax savings (“present value” benefit), and potentially qualifying for additional first-year depreciation or Section 179 deductions for non-building assets.
Additionally, cost segregation studies can help in accurately assessing insurance and property tax costs, and allow taxpayers to properly account for asset dispositions, such as when replacing parts of a building like a roof. However, caution is advised as improper or aggressive studies may lead to IRS scrutiny and challenges.
While cost segregation studies can be costly (typically $5,000 to $10,000 or more depending on complexity), they can yield substantial tax savings, often estimated at $40,000 to $50,000 in tax savings per $1 million of the building acquisition cost, though actual savings vary widely based on individual circumstances and the quality of the study performed. For more information on this topic, please contact a ShindelRock tax professional.