Cost segregation is a tax savings strategy that allows owners of commercial real estate to achieve significant cash flow savings by accelerating depreciation deductions and deferring federal and state tax obligations. This tool is extremely useful for entities that purchased, expanded, or remodeled real estate that is used in a trade or business.

What is cost segregation?

The primary goal of a cost segregation review is to segregate all property related to costs that can be more properly depreciated in the 5, 7 and 15-year categories. These depreciation categories are shorter than the otherwise required depreciable lives or 27½ or 39 years that are required for real property. A faster depreciation write-off period will result in a deferral of tax obligations – thereby saving significant cash flow for the typical entity.

A cost segregation study helps identify the personal property and land improvement components of the building cost that can be depreciated over shorter lives. Quite often these assets are embedded in the real property cost and they must be segregated by way of a detailed analysis to separately reclassify them as such. A study typically reviews construction and purchase records, blueprints, and other support and includes inspections and interviews to identify these items in a well-documented format. If none of this information is available a study can still be performed by using estimates made by qualified experts.

Personal property is depreciated over a 5- or 7-year life and includes items such as machinery and equipment, high-intensity lighting needed in operations, transportation equipment, furniture, storage racks, and other certain types of fixtures. A key to segregating personal property from the real estate is to evaluate the use of a particular component as it pertains to the primary operation of the business. Quite often if the component is integral to the operation of the business it may indeed be more properly categorized as personal property rather than as a part of the building.

Land improvements are depreciated over a 15-year life and include items such as parking lots, soil correction, and required landscaping, sidewalks, fencing, and drainage and irrigation systems.

Typically, up to 20-40% of a commercial property project cost is more properly classified into personal property and land improvement categories. This in turn will result in a present value tax savings ranging from 10-15% of the total project cost—as an upfront tax deferral. On a $5 million building cost, this could result in an immediate cash savings of $50,000-$100,000 or more.

Cost segregation can be applied to real property that has been constructed, purchased, or remodeled. A study can be done at any time subsequent to the acquisition of the property and your returns can be amended to reflect the new classifications and capture the tax savings.

How can we help?

LB Carlson has provided full-service financial and business management consulting for over 40 years. We understand the unique aspects of this strategic tax planning strategy and can identify where the opportunities exist when it comes to cost segregation. If you have any questions on this topic or would like additional information or a free preliminary analysis, please contact your LB Carlson representative.