It just beats the heck out of me why every commercial property owner is not taking advantage of Cost Segregation because they should be. This tax strategy is a very lucrative opportunity for commercial property owners to accomplish many of their financial goals simply by accelerating the depreciation on their property.
Yes, that's the key to Cost Segregation. Cost Segregation is an IRS-approved tax application by which commercial property owners can accelerate depreciation and reduce the amount of income taxes owed. This savings generates substantial cash flow that owners often use to reinvest in the business, purchase more property, apply to their principle payment or spend on themselves.
The Cost Segregation engineering analysis reclassifies the property assets such that 30% to 50% of the cost basis of the property can be depreciated over 5, 7 and 15 years instead of the entire cost over the traditional 39 years. This means that the property owner will typically realize $70,000 to $100,000 in tax reduction (cash flow increase) per million dollars of cost basis in their property. Not only are the property's assets properly classified, according to the IRS, but a significant tax savings (cash flow) is available for other uses.
Five year and 7 year categories might include such items as decorative building elements, electrical for dedicated computer equipment and carpet. The fifteen-year items might include site utilities, landscaping and paving.
More common today than just a few years ago, Cost Segregation is being used by more and more commercial property owners, CPAs, financial advisors and other financial and real estate professionals on behalf of their clients. Of course, the problem has been, and continues to be, a lack of recognition of the benefits and understanding of Cost Segregation by these financial professionals.
By now you should be asking "What commercial property qualifies for this tax strategy"? Well, that's pretty easy. Any type of commercial property qualifies that has been built, bought or renovated since 1987. That means office buildings, warehouses, self-storage facilities, retail strip centers, malls, medical facilities and any other commercial property.
Your next question might be "What, at a minimum, does my cost basis have to be to make a cost segregation study viable"? Also a pretty easy question. As a rule of thumb, the cost basis of the property should be $500,000 or more. That does not mean that property with a lower cost basis would not make sense. In many cases, properties with a cost basis as low as $250,000 make sense for many property owners. These lower cost basis properties normally become an owner decision based on the benefits that will be realized.
Okay, another frequently asked question is "I have owned my property for a few years, does it still qualify"? The answer is, yes. There is a provision in the code that allows owners to claim the cost segregation benefits retroactively as if they had started the process on the date they built, bought or renovated the property. Best of all, there is no requirement to amend any previous returns.
Many owners also ask "Can my CPA do these studies?" The fact of the matter is that, in virtually every case, your CPA does not possess the engineering skills to perform cost segregation studies as defined by the IRS. They normally will contact a qualified third party engineering firm on their client's behalf to explore the financial benefits for their client.
One final question, for this article, is "Why hasn't my CPA told me about this tax strategy?" The answer, in most cases, is that they don't know about it or they don't have a relationship with a third party engineering that can actually perform the engineering analysis.
There are only a couple of reasons that cost segregation does not apply. First, if the owner do not have a tax liability (such as a commercial building owned by a non-profit organization). Secondly, "flipping" properties creates substantial depreciation recapture issues as well as capital gains issues. We normally tell our clients that they should intend to own their property for at least five years. Because it is not always possible to control all circumstances, we also suggest that the owner have an exit strategy such as a 1031 exchange.
In summary, I hope it is clear that, as a commercial property owner, you should be taking advantage of cost segregation. If you are not taking advantage of this tax strategy, you most likely should be because you are foregoing a significant infusion of cash.