More tax deductions means tax reductionImportant Commentary for Owners of Real EstateBy Patrick O’Connor, MAIDepreciate Property Improvements Correctly…and Pay Less Federal Income TaxMost commercial real estate owners are paying excess federal income taxes because they are not depreciating their property as quickly as they should. A cost segregation study allows property owners to both defer and reduce federal income taxes. Cost segregation increases depreciation (a non-cash deduction) for commercial real estate owners. When properly performed by an appraiser with expertise in cost segregation, this is a conservative tax planning tool which reduces federal income taxes by properly allocating the cost basis between land, 5-year, 7-year, 15-year, 27.5-year and 39-year property.
Depreciation is an important non-cash tax deduction. The Myst Condo By increasing tax deductions, commercial property owners affect federal income tax reduction. The increase in tax write-offs generates such a large tax cut that some wonder if it is a tax shelter or tax evasion scheme. It is not. Cost segregation is an IRS-guided process used to increase tax deductions during the tax preparation process. The IRS has provided a detailed explanation of the items that qualify for short-life depreciation and acceptable methodologies for performing a cost segregation study. Cost segregation studies performed by appraisers in compliance with the IRS’s Audit Techniques Guide are unlikely to be challenged in an audit. Commercial real estate owners seeking tax advice and tax relief can benefit from reviewing the tax relief available from cost segregation.Cost Segregation Study Benefits include Tax Deductions and Tax ReductionBenefits of a cost segregation study are substantial, immediate and enduring. Year 1 federal income tax savings are typically at least two times the cost of a cost segregation study. In many cases they are five to fifty times the cost of the study. The present value of federal income tax savings for a property held for ten years are typically at least ten times the cost of the study. In many cases, the present value of tax savings as much as 30 to 50 times the cost of the report. The cost segregation study is only required once. Its cost is not recurring, but the benefits are recurring during the term of property ownership. A cost segregation study can also materially reduce local property taxes by separating real and personal property for newly constructed properties.Detailed ExamplePreparing a cost segregation study requires only a limited time commitment from the owner, perhaps 10 to 15 minutes. This limited commitment of time results in substantial federal income tax savings, which are both conservative in approach and well documented.
Some owners believe their accountant is properly segregating components into the proper classifications. Depreciation schedules are routinely generated by allocating the minimal amount to land and the balance to long-life improvements. Cost segregation supplements this approach by identifying and valuing short-life components. Many accountants and tax lawyers cannot thoroughly research this highly specialized field to understand the myriad number of items which can be segregated and are inadvertently overstating their client’s income tax liability. Furthermore, not obtaining a cost segregation study increases exposure in case of an audit since there is no clear audit trail.
A cost segregation study prepared by an appraiser with expertise in land valuation, construction costs and market value clearly documents each of these items. Further, a cost segregation expert can almost certainly sharply increase allowable depreciation.Following is a summary of the results of a cost segregation study based upon a recent assignment: Office BuildingCost Segregation Example Total costLandDepreciable basis $6,650,000$1,277,500$5,372,500Annual depreciation (using 39-year straight line) $137,756Accurate Cost Allocation and Depreciation after Cost Segregation Study Land5-year property7-year