While most property owners are aware of depreciation benefits, many do not take full advantage of them. It is rare that a building’s entire acquisition or construction cost should be depreciated over the 39-year or 27.5-year MACRS life assigned to real property. When property owners use this method of depreciation, they overlook the benefits of the federally accepted shorter depreciation lives for certain building assets. Depending on the type of assets present in a building acquisition or construction, typically there are significant assets having significant costs that would be considered personal property for federal income tax reporting purposes, and thereby qualify for a shorter depreciable life. The identification of these depreciable assets is referred to as a Cost Segregation Study. At Lighthouse Capital Advisors, we use IRS approved methods of identifying and quantifying these assets subject to receiving shorter tax life treatment.
The study is a facts and circumstances assessment of the building and its components. Different types of buildings have different assets, so reclassification amounts vary depending on the assets present at each specific building. However, for analysis purposes, we will analyze a property with a total cost (asset basis, not including land) of $3,000,000. If assets totaling 25% of the cost basis were reclassified to shorter MACRS lives such as 5 or 7 yr (10%), and 15 yr (15%) there would be a present value income tax savings of $90,000 (assuming a 35 percent tax bracket and an 5 percent discount rate). Therefore, it is easy to see the benefit of having a practitioner complete a Cost Segregation Study. At Lighthouse Capital Advisors, our principal has completed Cost Segregation Studies on all types of Real Property including Retail, Industrial, Multi-family, Office, and Corporate Assets.
Performing a Cost Segregation Study
Ideally, building owners should contract the Cost Segregation Study in the preconstruction phase of development projects. This allows the practioner to accurately track items that qualify for accelerated depreciation. The qualified items then are segregated from the general building costs and depreciated appropriately. However, in most cases, Cost Segregation Studies occur on completed properties. When this occurs, since construction has ended, detailed cost data is seldom available, and items that qualify for accelerated depreciation typically had not been segregated out. Rather they have been combined with the real property and booked as real property basis. In such cases, to properly segregate the personal property from the real property, material and labor costs associated with the personal property are estimated and then segregated from general building costs. When performing a study in this manner, it is imperative to follow and document accepted cost-estimating procedures to defend the study’s results in the event of an IRS audit.
Why hasn't my Accountant told me about this?
Benefits of a Cost Segregation
Immediate cash flow through accelerated depreciation.
"Catch up" depreciation from improperly classified assets in years past. Can be taken in the current year on properties constructed or purchased since 1987.
Study is performed by an independant party which can aid in the event of an IRS audit.
