Cost segregation is a tax strategy used by real estate investors and property owners to take advantage of accelerated depreciation for some assets that are a part of the property. Typically, commercial properties can be depreciated over a 39-year time frame. An engineering cost segregation study is performed on the property to break down the assets into four categories to determine which assets are eligible for accelerated depreciation.
Land – There is no depreciation for land so a value will be determined for just the dirt the building and parking lot sit on. This value will be deducted from the total price paid upon purchase of the real estate.
Land Improvements – This category includes improvements such as landscaping, fences, and paving. Once the value of these land improvements is determined the total will be deducted form the total property improvements which helps determine the value of the building.
Tangible Personal Property – This category includes items that are not structural to the building such as, carpet or tiles, restaurant equipment, or office furniture. Assets that are considered tangible personal property may have the potential to be depreciated sooner than the building itself.
Building – The value of the structural components of a building will be left over after all other categories have been assigned a value. These components are typically depreciated over 39 years, but the cost segregation process should quantify individual parts, such as roofing, elevators, and boilers, that may be replaced individually in the future. By quantifying their values up front, their remaining basis can be fully written off in the years they are replaced.
The value of the assets in the land improvements, tangible personal property and the replaceable assets within the building may be eligible to take advantage of accelerated depreciation which lowers the investors upfront tax liability and allows the investor to take advantage of the time value of money and place the tax savings into higher-return investments, or reinvest the savings into the same property.
To summarize, an engineering cost segregation study can help property owners and real estate investors depreciate certain capital assets more quickly than the land, either in the beginning, through reclassifying certain components to shorter depreciation lives and an accelerated depreciation schedule, or in the future, through early disposition and replacement of any component.