A cost segregation study is a way to increase cash flow – Real Estate & Construction
United States: A cost segregation study is a way to increase cash flow
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If your business is planning to buy, build, or significantly improve real estate, a cost segregation study can help you accelerate capital cost allowances, lower your taxes, and increase your cash flow. Even if you’ve invested in real estate in previous years, you may have the opportunity to do a retrospective and catch up on any deductions you missed.
Related Reading: Why a Cost Segregation Study is a Good Idea – Accelerating Capital Cost Allowances to Reduce Taxes and Increase Cash Flow
HOW IT WORKS
Generally, commercial real estate (other than land) is depreciable over 39 years and residential real estate is depreciable over 27.5 years. A cost segregation study identifies real estate components that are properly treated as personal property depreciable over five or seven years or land improvements depreciable over 15 years. By allocating a portion of your costs to these shorter-lived assets, you can accelerate capital cost allowances and significantly reduce your tax bill. If these assets are eligible for additional depreciation, the tax savings can be even greater.
In some cases, assets qualifying as personal property are apparent. Examples include furniture, fixtures, equipment and machinery. Often, the assets eligible for accelerated depreciation are less obvious. For example, components of a building that would normally be treated as real estate depreciable over 39 years may be classified as property over five or seven years if they are essential to particular business functions.
Example: A manufacturing company built a $20 million plant and commissioned it in June 2021. To accommodate its manufacturing processes, the design required a reinforced foundation, electrical and plumbing systems specialized and other structural components closely related to manufacturing functions.
A cost segregation study supports the allocation of $6 million of plant cost to these components which are depreciable over seven years instead of 39 years. As a result, the company increases its capital cost allowances by approximately $774,000 in year one, $1.05 million in year two, and $895,000 in year three (not including any additional depreciation available).
RECOVERY OF DEDUCTIONS
What if you had invested in a building several years ago and attributed the entire cost to real estate? Depending on how much time has passed and what documentation you have, it may be possible to conduct a retrospective study and reallocate some of the cost to short-lived personal assets. Asking the IRS for a change in accounting method may allow you to claim a catch-up deduction for the additional depreciation missed in previous years.
IS IT GOOD FOR YOU ?
Wondering if a cost segregation study would be profitable for your company? Your ORBA tax advisor can help you weigh the potential tax savings against the cost of a survey.
Related Reading: Using Cost Segregation Studies for Like Kind Exchanges
The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.
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