Unfortunately, there are quite a few misconceptions out there about cost segregation. I like to consider it a “gem” of a tax strategy.
Taxpayers who aren’t taking advantage are literally leaving money on the table. If you’re a CPA or financial advisor, make it a point to advise your clients on the financial benefits they may be missing out on. If you’re a real estate investor, become informed: You may be sitting on money.
So, what is cost segregation? Allow me to explain it in the simplest way possible.
Cost segregation is a tax planning strategy used by savvy commercial real estate investors that accelerates the depreciation of certain components of their properties. In return, this can reduce current tax liability, resulting in up-front cash flow.
The benefits of cost segregation are comparable to borrowing money from the government – interest-free. This is what I meant when I said people are leaving money on the table.
There are no rules when it comes to what you do with the cash. Typically, with real estate investors, I recommend using it to make improvements to a building, or, better yet, using it for the down payment on the next acquisition.
Now, on to how depreciation works.
Over time, the value of a building depreciates due to normal use and deterioration. In years past, the IRS considered a structure to be a single asset that depreciated in value in a straight line: over 39 years for non-residential commercial properties, or 27.5 years for commercial residential ones.
Let’s say you own a non-residential commercial building. During the first 39 years of ownership, you get a tax deduction of 1/39th of its value each year.
Although these depreciation expenses are helpful at tax time, there’s a smarter way to do it.
It’s common knowledge most components within a building don’t last 39 years. With cost segregation, pieces like carpeting, specialty lighting, certain plumbing fixtures and landscaping can be “segregated” from the building.
These segregated assets can be expensed faster – on a five-, seven- or 15-year schedule, based on their individual depreciable lives – as opposed to being part of the building’s 39-year, straight-line depreciation schedule.
As you can see, cost segregation is a great strategy for helping clients grow their net worth faster by significantly reducing their current tax liability and using the up-front cash for additional investing.
About Brian Lefever
As VP of Operations, Brian is responsible for continuous product development for Titan Echo (titanecho.com), a simple and cost-effective solution for CPAs to provide cost seg benefits to their clients without engaging an outside consultant or hiring an in-house engineer. Based in Denver, CO, Titan Engineering is the team that built the Titan Echo CostSegregation Software – as well as the Titan Armor R&D Tax Credit Software.