James Lamont of Lamont Financial Services explains how cost segregation, an IRS approved method of asset classification, can help commercial property owners cut taxes and increase cash flow.
Cost segregation is an IRS-approved procedure that allows commercial real estate owners to divide their property into two separate asset classes–real property and personal property–for tax reporting purposes. IRS rules allow owners to depreciate personal property and property improvements faster than real property.
Why should you care? Well, if you own commercial real estate, you may be sitting on a pile of cash you didn’t even know you had!
Standard depreciation for commercial real property is 39 years. The IRS allows personal property, depending on the nature of the assets, to be depreciated over 5, 7, and 15 years. Dividing property into separate asset classes allows owners to accelerate depreciation tax deductions, reducing their tax liability and increasing cash flow.
Dividing a property into real and personal assets is a bit complicated and the IRS recommends using an engineer to make sure it is done right. What it really boils down to is that anything that can’t be removed from the building can likely be classified as personal property. This includes non-structural elements such as wall coverings, carpet, accent lighting, portions of the electrical system, machinery and equipment, and exterior site improvements such as sidewalks and landscaping. The classification of assets is best done using a blueprint that identifies all of the visible and non visible components of the building and property around it.
How much money can you recoup through cost segregation? Every property is different, but a common “ballpark” estimate is that typically 25 to 35 percent of a property’s value can be accelerated. This means that for every $1,000,000 of cost shifting from 39-year real property to 5-year personal property, the net present value of the tax benefit is approximately $100,000.
The first step in pursuing cost segregation for a property is to perform a cost segregation study. A cost segregation study is performed by engineers that comb through a building’s blueprints to prepare a report that details the assets that qualify as personal property. This report is the documentation you will need to support your tax claims. It’s important to note that this is not a building inspection but an engineering study. The reason for this is that the IRS has stated to its agents that a “detailed engineering approach” to cost segregation “is the most methodical and accurate approach, relying on documentation and minimal estimation.” In other words, the IRS will accept a cost segregation engineering study as proper documentation for asset classification.
The eligibility requirement for cost segregation is that the owner is must be paying federal taxes, and that the building was put into service after 1987 (the year that the IRS introduced shorter depreciation schedules for personal property assets). Existing properties, new construction, leaseholds, renovation/remodeling, or abandoned properties slated for demolition are all eligible. Practically speaking, a building should have a cost basis of at least $500,000 in order for a cost segregation study to be cost-effective. It is also recommended by most cost segregation consultants that the owner keep the property for at least 12 months after performing the study to realize its benefits.
If you have owned a building for several years and haven’t performed cost segregation, it’s not too late. The IRS allows owners to “catch-up” and recover any missed deductions since 1987, which could result in an immediate windfall for owners that have held their properties for many years.
Is cost segregation right for you? The best way to find out is to contact a financial advisor, CPA, or engineering firm that specializes in cost segregation studies. Most will conduct a free feasibility study to give you an idea of what benefit might be available for your specific holdings.
Lamont Financial Services offers cost segregation services in partnership with Core Solutions Group. Core is a one of the nation’s most trusted authorities on cost recovery for commercial real estate owners and investors. For a free assessment of your property, contact James Lamont at Lamont Financial Services.