What is a Cost Segregation Analysis?
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A cost segregation study is the strategic process where a cost segregation consultant analyzes commercial real estate to determine whether identifying and segregating certain components of the property as personal property (Section 1245 Property) that are separate and distinct from the real property (Section 1250 Property) will produce any accelerated depreciation benefits for income tax purposes.
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The objective of a cost segregation analysis or study is to segregate assets into four (4) distinct asset class categories, including:
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personal property; or
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land improvements; or
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buildings or structures; or
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land
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Personal property such as furniture and fixtures, carpeting, and window treatments is depreciated over a 5 or 7 year depreciable life. Land improvements such as sidewalks, paving, or landscaping, are subject to a 15 year depreciable life. The actual buildings or structures are depreciated over 27.5 or 39 years depending on the type of property. Land is not depreciated.
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Tangible personal property is described as all property other than the structural components that are part of or attached to a building or structure. This includes office furnishings, equipment, cabinetry, and floor coverings. Structural components of a building are described as property that relates to the operation or maintenance of a building, such as some types of lighting fixtures, air conditioning (HVAC) systems, plumbing and wiring.
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What Does the Cost Segregation Analysis Do?
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The cost segregation consultant will identify those components of the property that can be considered to be personal property as described above and will reclassify those assets into the applicable shorter depreciation periods in order to generate additional depreciation deductions for income tax purposes.
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Real property components that are reclassified as personal property can be depreciated faster over 15, 7 or even 5 years instead of the standard 39 year depreciable life for non-residential real estate and 27.5 year depreciable life for residential real estate.
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The final written cost segregation study or report will provide real estate owners with the information needed to calculate the accelerated depreciation deductions for income tax purposes. The cost segregation study will also serve as the supporting documentation during any IRS audit.
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What are the Benefits of a Cost Segregation Study?
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Commercial real estate owners can shelter significantly more taxable income from real estate operations due to the accelerated depreciation deductions. Sheltering additional taxable income means an immediate reduction in the amount of income taxes actually paid in the current tax year, which translates into an immediate increase in cash flow from real estate operations. It is another method by which commercial real estate investors can defer the payment of their income taxes.
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Who Qualifies for Cost Segregation?
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Generally any commercial real estate acquired or built and placed into service after 1986, including any new acquisition, real estate construction, building, or improvements, will qualify for cost segregation.
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