Preserving Cash Through Cost Segregation

May 23, 2010

by Leo Charpentier

A safe and effective way to depreciate income-producing real property faster than over the typical 39 or 27.5-year lives We have great news for owners of income-producing property who are looking to shelter that income through depreciation.  The IRS has accepted an important tax strategy called a Cost Segregation Study that sharply increases depreciation deductions in the first few years of ownership.  More tax depreciation deductions result in a lower tax bill and that means more money in your pocket.
Typically, the entire cost of a building is lumped into a 39-year or 27.5-year depreciation category.  Multiple tax court cases have established that certain elements of a building's cost can be depreciated over much shorter periods such as 5, 7 or 15 years.  Those elements have to be identified and the cost assigned to them has to be determined by an acceptable method, must be reasonably proportional and needs to be supported by appropriate documentation. 
The IRS has published an Audit Technique Guideline that defines a standard for a "Quality" Cost Segregation Study.  By carefully adhering to that standard, your Cost Segregation Study can be a safe and extremely effective tax strategy at the same time.
Just how effective is a Cost Segregation Study?  Usually, anywhere from 10-30% of a building's cost can be reclassified to shorter depreciable lives.  As an example, an average building costing $1M will produce federal tax savings between $14,000 and $40,000 in the first five years of ownership.  In many cases, state tax savings can be realized as well.
And don't forget, for each of those early years of ownership, you'll have tax savings that can be used to further invest into real property, to lower mortgage debt or to use as you see fit
Here's more food for thought:  those higher tax deductions are protecting income that otherwise would be taxed at ordinary tax rates. Each time you take a depreciation deduction, you lower your basis in the property for tax purposes.  Lower basis means a higher capital gain.  By using the higher depreciation produced by a cost segregation study, you effectively take income that would have been taxed at ordinary rates and instead subject it to lower capital gains tax rates. 
One last thing, if you're ruing the fact that you didn't know about this valuable strategy four years ago when you bought that building, the IRS allows you to "Catch-up" in the year of the Study by making a Section 481(a) adjustment.

Anyone who has bought or built an income-producing property with a cost of $500,000 or more over the past four years would be well-served by looking into this safe and very effective strategy to preserve cash through tax savings.

Dynamic Business Solutions
a division of Dynamic Lease Corporation
1395 Atwood Ave., Suite 209E
Johnston, RI 02919
Tel. 401-432-7700, Fax 401-432-7701


A collection of books from B2B CFO® to help any business succeed. Read the first chapter from books, including the Wall Street Journal’s book, for free.