Cost Segregation

Detailed studies that maximize depreciation

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What Is Cost Segregation?

Cost Segregation is a highly beneficial and widely accepted tax strategy utilized by owners of commercial and residential rental property to accelerate depreciation deductions, defer taxes, and improve cash flow. A quality study provides the appropriate documentation needed to support the correct classification of depreciable assets related to a building and exterior improvements. It is important to note that a Cost Segregation study does not create new deductions, it simply increases deductions in the early years of ownership. This front-loading of depreciation allows the taxpayer to take advantage of the time value of money. 

From a tax perspective, Cost Segregation should be considered routine for all property owners who own or manage real estate. Not only will a study support accelerated depreciation by reclassifying eligible assets into shorter lives it but can provide valuable data to support important tax-centric initiatives during the holding period of the property.

What is a Cost Segregation Study?

A Cost Segregation study is a detailed analysis conducted by tax professionals, engineers, or specialized consultants to identify and separate the various components of a commercial or rental property for tax purposes. The objective of the study is to reclassify assets from longer depreciation periods to shorter ones, in order to accelerate tax deductions and improve cash flow for the property owner. 

During a study, the property is thoroughly examined, and its components are categorized into different asset classes, each with its own depreciation schedule according to the IRS guidelines. These asset classes typically include:

By identifying and segregating these assets, these studies allow property owners to maximize their tax savings and increase cash flow. It’s important to note that a study should be performed by qualified professionals, as it requires a deep understanding of tax law, construction techniques, and engineering principles.

Eligibility of Building or Improvements

A Cost Segregation study helps to identify parts of a building or its improvements that can be depreciated faster, leading to tax savings. A building or its improvements may be eligible for such a study if:

How Does a Cost Segregation Study Work?

The objective of the study is to identify Section 1245 and Section 1250 property that will be eligible for accelerated depreciation.  In many cases, a more detailed approach will be required for the quantification and pricing of 27.5 and 39-year property depending on facts and circumstances.  A study can be performed on recently acquired or constructed properties or for those that have been in service for several years. We make a point of understanding your operational strategies to ensure that our Scope of Services are closely aligned with both short- and long-term needs.

It’s important to note that these studies should be conducted by qualified professionals, as improper classification of assets can lead to IRS audits and penalties. Also, property owners should consult with their tax advisors to understand the specific implications and benefits of a cost segregation study for their situation.

The property owner or investor hires a professional firm with expertise in cost segregation to conduct the study. It is essential to engage a qualified and experienced team to ensure accurate results and compliance with tax laws.

The cost segregation team conducts a preliminary analysis to determine the potential benefits of the study, including estimating the tax savings and return on investment. This step helps the property owner decide whether to proceed with the study.

The cost segregation team visits the property to gather relevant data, inspect the building, and identify the assets that can be reclassified. The team may also review construction documents, blueprints, and other related records to collect necessary information.

The team analyzes the gathered data and classifies the property’s assets into different categories based on their useful life, as defined by the IRS. The primary categories are:

  • Personal Property (Section 1245): These are tangible assets with a shorter useful life, usually 5, 7, or 15 years. Examples include furniture, fixtures, and equipment.
  • Land Improvements (Section 1250): Assets that have a useful life of 15 years and are associated with the property’s exterior, such as landscaping, parking lots, and exterior lighting.
  • Building Structure (Section 1250): The core building structure and components that have a longer useful life, typically 27.5 years for residential properties and 39 years for non-residential properties.

The cost segregation team prepares a comprehensive report that documents the methodology, findings, and asset reclassification. This report serves as a support document for the property owner’s tax filings and helps demonstrate compliance with IRS guidelines in case of an audit.

With the cost segregation study complete, the property owner or their tax advisor can adjust the depreciation schedules on their tax returns accordingly. This often results in accelerated depreciation deductions, which can lead to substantial tax savings and improved cash flow.

What Are The Benefits Of A Study?

There are a number of benefits associated with a Cost Segregation study and its various applications. To the extent you have taxable income, a study will help mitigate some or all of the tax liability for the current and possibly future years. This is most often achieved through the acceleration of depreciation deductions and the resulting tax deferral. The study will identify assets that are eligible for Bonus Depreciation treatment.

When prepared correctly, these studies can also be an excellent reference tool to deploy the various strategies available to property owners as contained in the Tangible Property Regulations with respect to expensing of certain incoming improvements as well as taking advantage of the Partial Asset Disposition (PAD) deduction.

Also, in light of the Tangible Property Regulations, a comprehensive study such as, Fixed Asset Review, can also properly document all assets that might be subject to disposition in the future.”

To learn more about using cost segregation throughout the Life Cycle of Real Estate, and the additional benefits that may be available please visit our Life Cycle of Real Estate page.

When Should a Study be Conducted?

The timing of a cost segregation study can have a significant impact on the potential benefits and tax savings. Here are some ideal scenarios when a study should be conducted:

Conducting a study shortly after the construction or acquisition of a commercial property ensures that the maximum tax benefits are captured from the beginning. This also allows for more accurate data collection and easier access to relevant records.

If you have recently completed renovations or improvements to your property, it’s an excellent time to conduct a cost segregation study. The study can help identify assets with shorter depreciable lives, allowing you to accelerate depreciation and benefit from immediate tax savings.

If the property’s use has changed, such as converting a warehouse into office space, it may warrant a new cost segregation study. This can help identify assets eligible for accelerated depreciation based on the new usage.

If a cost segregation study was not performed at the time of acquisition or construction, a “catch-up” study can still be conducted. This allows you to claim any missed depreciation deductions in the current tax year by filing a Form 3115 (Application for Change in Accounting Method) with the IRS. This can result in a significant tax saving without amending prior years’ tax returns.

If your business has experienced a profitable year and you need to minimize your tax liability, a cost segregation study may help by accelerating depreciation deductions and reducing your taxable income.

If you have made significant leasehold improvements to a rented property, a cost segregation study can help identify and allocate costs to shorter-lived assets, allowing for quicker cost recovery.

The Source Advisors Advantage

The Cost Segregation landscape has evolved significantly over that past two decades. Now more than ever, property owners and accounting firms are seeking to work with established specialists such as Source Advisors. 

One of the most noteworthy advancements in the Cost Segregation landscape was the introduction of industry standards by the American Society of Cost Segregation Professionals (ASCSP) in 2009. For the first time ever, the ASCSP established professional certifications, setting a high bar for expertise and ethical conduct in Cost Segregation studies.

In an industry where expertise and specialization are paramount, Source Advisors is proud to have a team that includes 8 ASCSP Certified members. While this number may seem small at first glance, it becomes highly significant when you consider that there are fewer than 50 Certified members across the nation.

Source Advisors remains committed to providing top-notch Cost Segregation services, leveraging our extensive experience and ASCSP-certified expertise to maximize your tax benefits.

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Frequently Asked Questions

What if my commercial property business is audited by the IRS - Will Source Advisors be available to help me?

Yes. At Source Advisors, we stand behind our Cost Segregation services. Our team provides unparalleled studies that result in meticulous attention to detail identifying construction-related costs.

How long does a Cost Segregation study take to complete?

A study typically takes 30-45 days to complete. The Source Advisors team will keep you up to date throughout the process and answer any questions you have regarding the services being conducted.

What information do I need to provide Source Advisors for an estimate?

The more detailed information you can provide, the better. This ensures a more accurate estimate, and we might ask for additional information to clarify our understanding of your particular project and needs.

At minimum, we need:

  • Capitalized costs for your project
  • Years that it was capitalized in
  • Depreciation schedule, if available
  • Brief description of your business
  • Number of floors, square footage of the building site
  • Property address

How much does a Cost Segregation study cost?

The IRS specifies the cost of a study should be based on the time required to perform the study; not a percentage of the projected or realized savings. The time involved in a study is driven by multiple factors.

Here are just a few aspects of the project that will impact the time involved to perform the study:

  • How big is the building?
  • What is the business activity in the building?
  • How many tax years will be analyzed?

What is Cost Segregation in real estate?

In real estate, Cost Segregation is a tax benefit strategy that is recognized by the IRS. It involves identifying specific components within a building or improvement project that can be classified differently for federal tax purposes—either as personal property or as land improvements, rather than as real property. This reclassification allows for accelerated depreciation schedules.

For example, the costs related to personal property components can be depreciated over a 5- or 7-year period, and land improvements can be depreciated over a 15-year period. This is faster than the standard 39-year or 27.5-year depreciation schedules typically applied to real property, thus providing potential tax advantages.

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Cost Segregation Insights