James Lamont of Lamont Financial Services explains how property owners can use cost segregation and IRS approved asset classification methods to recover depreciation deductions from the past, present, and future.
Cost segregation is an IRS-approved tax saving strategy that allows commercial property owners to divide their properties into two categories: real property and personal property. The benefit of this “reclassification” is that personal property can be depreciated much faster (5, 7, and 15 years depending on the asset) than real property (39 years). This means that property owners can lower their tax burden and increase revenue simply by reclassifying assets they already own.
Cost segregation can be applied to buildings placed in service or significantly remodeled after 1987 (the year that current depreciation schedules were put into place). Many property owners aren’t aware of cost segregation and have not taken advantage of the opportunity. Some haven’t heard of it. Some have heard of it and think it might be frowned upon by the IRS and trigger an audit. It won’t–the IRS actually tells you how to do it.
Those who haven’t heard of cost segregation and have owned buildings for many years are allowed to “catch up” with their depreciation schedules and enjoy a significant windfall of tax savings and new cash flow. In 1999, the IRS announced that it would permit companies that have claimed less than the allowable depreciation in prior years to claim the missed depreciation. In 2002, the IRS announced that all of the prior years’ depreciation that is allowable under a cost segregation approach might be claimed in the change year. This means that owners can get the benefit of all the depreciation that they haven’t claimed in the past. The ability to claim several years’ worth of depreciation in a single year makes this a potentially lucrative tax benefit.
A common misperception is that the catch-up rule is complicated and will force owners to re-file taxes for each year in which they have owned the building.
Actually, catching up is much easier than you might think. You only need to file IRS Form 3115 (Change of Accounting Method ) to take the “catch-up” depreciation deduction in the year you perform and submit a “cost segregation study”–the approved method of documenting and valuing asset classification.
It is important to understand what a cost segregation study is and what it isn’t. It isn’t a building inspection. It is an engineering-based study of a building’s assets–visible and invisible. It identifies and classifies everything from parking lots to plumbing, and there are many more assets that can be defined as personal property than most people think (including plumbing!). Each asset is identified and is assigned its shortest recovery period in which it can be depreciated (5, 7, or 15-year for personal property vs. the traditional 39-year period for real property). This allows owners to increase depreciation deductions, reduce the income tax liabilities and, maximize cash flow from their real estate investment.
The cost segregation study is the method of classification approved and accepted by the IRS. It should be performed by a qualified cost segregation professional–an accounting, advisory or engineering firm that specializes in the practice.
So, that’s all you need, a cost segregation study and an IRS form 3115. Each only needs to be performed once in order to claim past, present and future depreciation benefits.
Lamont Financial Services offers cost segregation services in partnership with Core Solutions Group. Core is one of the nation’s most trusted authorities on cost recovery for commercial real estate owners and investors.