Things to Consider Before Hiring a Company for Cost Segregation Studies
Cost segregation studies done by cost seg companies offer business owners in a variety of industries a workable tax technique to increase return on investment in real estate. It can be a powerful strategy for commercial property owners who purchase or develop real estate to maximize depreciation deductions and reduce their tax burden.
A cost segregation analysis can maximize total cash flow opportunities for business owners who have invested money in building, buying, or renovating commercial properties. This will reduce their tax obligations and hasten the depreciation of their real estate assets. However, due to a lack of understanding of how cost segregation studies function or what they may accomplish, real estate owners, investors, and tax advisors frequently ignore them.
Real estate investors can methodically segregate personal from the real property by reclassifying particular parts of their commercial building. This will speed up overall depreciation, cut total taxable income, increase access to capital, and maximize tax-deferred benefits.
This blog provides you with an explanation of the cost segregation process, its workings, and benefits, as well as tips to keep in mind when hiring cost seg companies for your business.
A cost segregation study: what is it?
Property owners and real estate investors typically depreciate the commercial property over 39 years and residential rental property over 27.5 years for income tax reasons.
But a house, an office, a warehouse, or other real estate is never just the building. It also contains a number of additional components, like carpets, fencing, sidewalks, and plumbing fixtures.
These assets could be depreciated over five, seven, or fifteen years if purchased separately. However, they are often acquired as part of the construction of a building. Later, they are written off over the same 27.5 or 39-year useful life as the rest of the structure.
A cost segregation analysis examines each component of a structure, divides them into various categories, and enables you to take advantage of an accelerated depreciation schedule for some of those building elements.
What is the cost segregation process?
A cost segregation analysis aims to identify all property-related expenses that can be written off more quickly using bonus depreciation, which is 100% through 2022, over a period of five, seven, or fifteen years.
The team from cost seg companies examines the available property records, inspections, cost information, and designs to do this and may even conduct a physical inspection of the property.
When conducting a cost segregation analysis, the consultant will include every structural element that qualifies as personal property. Once that is done, they will try to fit into smaller period of depreciation. When it comes to tax season, this will result in more deductions.
Any real estate assets that are categorized as private property are subject to accelerated depreciation. In contrast, the typical depreciation period for commercial real estate is 39 years, and the typical residential properties, the depreciation period is 27.5 years.
After the cost segregation study by cost seg companies, the final draft will be used as the foundation for computing accelerated depreciation deductions throughout the tax season. In the event of an IRS audit, this computation will kick in for a basis for faster depreciation.
The time required by the customer and their accountant to complete a cost segregation study is typically between four and six weeks.
Why is it important for property owners to conduct a cost segregation study?
Because of the advantages it offers in terms of money; it’s important to separate a property’s costs. The study has a one-time expense, but over a number of years, the tax benefits from accelerating depreciation deductions can lead to a much higher cash flow.
You can reap the rewards of the time value of money with a cost segregation analysis. That also implies that if you don’t intend to keep the property for a long time, you might not gain from having a cost segregation study, as any initial advantages disappear upon property sale.
It’s conceivable that your business might significantly reduce its taxable income by carrying out a cost segregation study. Your cash flow would thus be more readily available as a result. To do this, assets are transferred from lengthy tax life categories to short tax life categories.
If this is successful, it will mean that the physical asset will depreciate more quickly in the beginning. The taxable income is consequently decreased. Your business will have more resources available for ongoing operations, corporate expansion, and reinvestment with a lower taxed income.
Some of the advantages of the cost segregation study are as follows:
1. A reduction in local property transfer taxes
Local real estate transfer taxes may be reduced as a result of cost segregation. These fees are frequently imposed by local governments based on the fair market value of a property. The amount of transfer tax that needs to be paid decreases when a building’s value is decreased through a cost segregation study (and a potential reduction of annual real estate taxes as well).
2. Factor in time value of money
The fundamental advantage of cost segregation is that bigger depreciation deductions are not usually the result (except, however, to the extent that the land component of the purchase has had its depreciable basis allocated elsewhere.) Instead, compared to spreading the deductions out over longer periods of time using slower depreciation methods, the benefit of these front-loaded deductions will be noticeably higher.
3. It is possible to write off an excess tax basis
The ability to write off the remaining tax basis in the event that a construction component needs to be replaced later is another advantage of cost segregation.
Assume, for instance, that a cost segregation analysis determined the initial value of a ceiling to be $800,000. The ceiling will need to be replaced when the property’s adjusted tax basis reaches $780,000 after two years. The taxpayer was allowed to deduct a loss of $780,000. If the taxpayer had not performed the cost segregation study, the result would have been drastically different because there would be no loss. After all, the tax bases of the building and the ceiling would still be linked.
Things to consider when choosing companies for cost segregation services
1. Final report breakdown
Do the engineering reports mention the “roofing” components simply as “roof,” or are they unique to your property? As you might expect, the price of a metal roof is far more than that of a flat or asphalt shingle roof system. A storefront window system is significantly more expensive than a typical single-hung window. Again, this is crucial for dispositional purposes and, essentially, how things ought to be done.
2. Fully engineered cost segregation studies
Do the cost seg companies you’re considering hiring, offer studies that cover every aspect of the project? It is a very significant factor. Are the 39 Year components left as a lump amount, and only the 5 and 15 Year properties have broken out? When you later try to claim objects for disposition purposes for any renovations or enhancements, you are practically left empty-handed. Are you essentially receiving what you paid for?
3. Site inspections by qualified personnel
Are qualified engineers performing site assessments and finishing the engineering for the projects for which they performed the site assessments? It is a very significant question. An engineer is a sole person with access to the crucial components of a project when he visits a site for one that he is working on.
This offers considerably more precision and detail. Dispatching images and comments back to the office so that someone else may write engineering reports does not give the customer the necessary detail or cover all the project’s components.
What to expect from a cost segregation analysis?
A thorough, engineering-based analysis is necessary for high-quality cost segregation research. Throughout the process, your assigned study engineers will analyze key documents like leasing agreements, cost information, and building blueprints in-depth.
A thorough on-site property inspection is another essential component of top-notch cost segregation research. Your expert cost segregation team will establish a breakdown of costs after evaluating the site and the pertinent documentation. They will then assign each cost to a designated recovery period, which typically ranges from 5 to 39 years, depending on the particular facts and circumstances of the project. One thing to keep in mind is that your engineering-based research will analyze all depreciable costs rather than just those expenses that qualify for a shorter recovery period.
Cost segregation has many more benefits than drawbacks. Cost segregation is the king when it comes to real estate purchases since it enables larger depreciation deductions. If the cost of the components is well documented in the engineering report, the cost segregation strategy is no more aggressive than applying an Internal Revenue Code-authorized depreciation method.
If you work with the best cost seg companies, you won’t have to worry about employing it. All you want is a qualified tax expert to walk you through the process and assist you in determining whether it is the best fit for your property. The professionals at Lindon Engineering employ decades of experience in engineering cost analysis and can provide you expert assistance with your cost segregation studies with quality results.