Tax resolution is one of the principal areas of focus at MCC. Given that this is the case, it’s only natural that we should be concerned with any strategies which can produce tax savings. We’ve spent considerable effort on various tax avoidance and tax reduction strategies. We’ve highlighted the benefits of a Section 1031, Section 368, as well as elaborate strategies such as the loans to avoid gift tax. We’ve even looked at various depreciation methodologies. In our quest to assist our readers and prospective clients, we’re always on the lookout for new tax strategies. One strategy which our readers may not be yet familiar with is a cost segregation study. Cost segregation studies have the potential to give you access to larger deductions on a much faster schedule. These deductions can have a tremendous impact on the fate of a company.
In this post, we will go over the specifics of cost segregation studies. We will discuss how these studies operate, the process involved and when it may be beneficial to apply them. These studies may not always be usable, but when they are, they can be highly effective. Let’s take a look at the mechanics of these studies in greater detail.
General Overview of Cost Segregation Studies
Simply put, a cost segregation study is a process whereby the real property and personal property assets of a given structure are classified separately. Suppose a company decides to construct a new commercial building in which they plan to conduct business. The commercial building is built so that it provides all of the functions necessary for the business to operate. This means it provides ventilation, electricity, and so forth. When the structure is fully complete, the company may depreciate this property according to its applicable depreciation schedule. For a commercial building, this means that they may depreciate the structure over a period of 39 years.
For some property owners, this period of 39 years may be less than desirable. Fortunately, cost segregation studies may provide an avenue to shorten the depreciation schedule for a certain portion of their construction. Certain parts of the building may be eligible for classification as personal property assets for tax purposes. And if certain parts can be classified as such, this will greatly shorten the depreciation schedule for those parts. Certain personal property assets may be depreciable over a schedule of five or seven years, for instance. This is much, much shorter than the schedule for commercial real estate.
In general, the “non-structural” elements of a building may be classified as personal property. This generally means wall covering, carpet, the electrical system, the lighting system, and so forth. External land improvements, such as sidewalk improvements and landscaping, may also be classified in this same manner.
Accelerating Depreciation Deductions
If a cost segregation study does, in fact, result in a host of separate classifications, then the owners of the property may depreciate their assets accordingly. This means that the owner will continue to depreciate the real property according to its normal schedule of 39 years. But, the personal property assets may now be depreciated more quickly. The result is that owners will be able to take advantage of larger deductions because of the accelerated schedule which applies to the personal property.
Let’s look at a quick example. Suppose a commercial building has a depreciable value of $1 million. This $1 million value applies to both the real property and personal property assets of the construction. Let’s further suppose that, following a cost segregation study, the construction is found to contain $300,000 in personal property assets. If the owner simply depreciated the entire property according to the real property schedule, the owner could take a yearly deduction of about $25,641. If we assume that all of the personal property assets have a depreciation schedule of seven years, then the owner can take a larger yearly deduction. The personal property assets will yield annual deductions of $42,857. This would be on top of the real property deductions, which would be $17,949 (because only $700,000 would now be real property). We can see that this translates into a huge tax savings in the short-term.
Short Term Tax Benefits
If the cost segregation study doesn’t lead to separate classifications, the owner will still ultimately depreciate the full value of the structure. But the key benefit is the short-term tax savings. As we know, time is very often equivalent to money, and owners can access greater amounts of money in the short-term with a cost segregation study.
Cost Segregation Studies Require a Specialist
In most cases, those interested in this type of service will need to hire a cost segregation specialist. These types of specialists generally have expertise both in tax and also architecture or engineering. Cost segregation specialists generally have to be able to read complex architectural or engineering specifications. In order to prevent any mishaps, it’s worth it to invest in a qualified specialist with plenty of experience. In general, cost segregation studies are only financially sensible for structures above a certain value threshold. This threshold will be different depending on the financial needs of the company as well as the cost of the study itself.
Call Us For Help!
At Mackay, Caswell & Callahan, P.C., we focus on a diverse range of tax matters. Our focus is on tax resolution, including resolution of New York and IRS tax debts, but we cover other areas as well. And we know that tax savings is the best way to prevent tax problems. If you can reduce your tax burden, this is the best step toward preventing future problems. If you do happen to get into tax trouble, though, we’re here to help. Reach out to one of our top New York City tax attorneys if you need assistance.