For businesses or investors that acquire, construct, or substantially improve depreciable real estate, cost segregation studies can provide significant financial benefits. These studies apply engineering and cost accounting principles to identify costs that can be reallocated to asset classes with shorter depreciable lives. A cost segregation study can also enhance the benefits of bonus depreciation and Sec. 179 expensing.
Generally, commercial buildings are depreciable over 39 years, while residential rental buildings are depreciable over 27.5 years. A cost segregation study identifies building components — such as equipment, machinery, fixtures, and land improvements — that are eligible for accelerated depreciation, typically over five, seven, or 15 years. The result:
- Accelerated depreciation deductions,
- An immediate reduction in tax liability, and
- Improved cash flow.
Keep in mind that a cost segregation study doesn’t increase your depreciation deductions, it merely accelerates them. After year two, your deduction amounts will gradually decline and eventually drop below the straight-line depreciation level. But the tax and cash-flow benefits of accelerated depreciation in the early years can be substantial.
An Added Bonus
In addition to accelerating depreciation, a cost segregation study can enhance the benefits of bonus depreciation or Sec. 179 expensing. Bonus depreciation allows you to immediately deduct 100 percent of the cost of qualifying assets placed in service after Sept. 27, 2017, and before Jan. 1, 2023. Beginning with assets placed in service after 2022, bonus depreciation is gradually phased out as follows:
- 2023: 80%
- 2024: 60%
- 2025: 40%
- 2026: 20%
- 2027: 0%
Sec.179 of the tax code allows you to immediately deduct the entire cost of qualifying equipment or other fixed assets up to specified thresholds.
By identifying property that qualifies for these tax breaks, a cost segregation study can boost your deductions and generate substantial present-value tax savings.
Is It Right for You?
It probably doesn’t pay to conduct a cost segregation study if you pay little or no income tax or if you plan to sell the building within the next five years or so. But in most other situations, the benefits of a study should far outweigh its costs.
Even if you acquired, constructed, or substantially improved a building in a previous year, it still may be possible to reap the benefits of a cost segregation study. Using a “look-back” study, you can claim missed depreciation deductions from previous years by filing Form 3115 — Application for Change in Accounting Method — and taking a one-time “catch-up” deduction on your tax return for the current year.