By Brandon French
A cost segregation study is a strategic tax planning tool used to accelerate depreciation deductions, thereby reducing taxable income and increasing cash flow for property owners. Taxpayers that are unfamiliar with the concept will default to capitalizing building costs and depreciate those over a 27.5 year or 39 year period depending on the type of building.
Identifying Cost Segregation Candidates:
Determining whether a building is a good candidate for a cost segregation study involves several factors related to the property’s characteristics, acquisition details, and the owner’s financial objectives. The following is a summary of issues to consider when analyzing a cost segregation study:
- Type of Property: The following property types are prime candidates to explore the benefit analysis for a cost segregation study:
Commercial Properties
- Office Buildings: Standalone offices and corporate headquarters with components like carpeting and lighting.
- Retail Spaces: Shopping centers, strip malls, and retail stores with specialized lighting and signage.
- Industrial Properties: Manufacturing plants and warehouses with heavy machinery and specialized HVAC systems.
- Hospitality Properties: Hotels, resorts, and bed-and-breakfasts with furnishings, kitchen equipment, and landscaping.
- Healthcare Facilities: Hospitals, clinics, and medical offices with specialized medical equipment and lab setups.
- Restaurants and Food Services: Restaurants, fast food outlets, and bars with kitchen equipment and décor.
- Automotive Facilities: Car dealerships and service centers with service equipment and display areas.
- Recreational and Entertainment Venues: Movie theaters, amusement parks, and fitness centers with seating and sound systems.
Residential Rental Properties
- Apartment Complexes: Multi-family buildings with appliances, carpeting, and fixtures.
- Condominium Buildings: Multi-unit residential buildings with individual and common area assets.
- Single-Family Rentals: Homes rented out with depreciable assets like landscaping, finishes and furnishings, and appliances.
- Student Housing: Properties for student accommodation with shared amenities and furnishings.
- Senior Living Facilities: Assisted living and retirement communities with specialized equipment and amenities.
Specialized Properties
- Technology and Data Centers: Buildings housing data centers and tech labs with technological equipment.
- Agricultural Buildings: Barns and greenhouses with specialized agricultural equipment.
- Educational Institutions: Private schools and colleges with classroom furnishings and lab setups.
- Religious Buildings: Churches and places of worship with unique features and equipment.
- Mixed-Use Properties: Buildings combining residential, commercial, and/or industrial uses.
- Property Value
Higher Value Properties: Buildings with a depreciable cost basis (excluding non-depreciable land value) of $500,000 or more typically benefit the most from cost segregation. The higher the property value, the more substantial the potential tax savings.
- Property Age
Recent Acquisitions: Properties acquired in the last few years are excellent candidates since the potential for recapturing missed depreciation deductions is higher. There is a common misconception that a cost segregation study needs to be performed in the year of acquisition. However, older properties can still benefit, but the immediate impact might be less significant unless substantial improvements or renovations have been made. There is no requirement to amend tax returns for older properties as a form 3115 change of accounting method can be filed for look-back years.
- Ownership Intentions
Long-Term Ownership: Owners who intend to hold the property for an extended period stand to gain more from the accelerated depreciation benefits. This is because the tax savings accumulate over several years, enhancing long-term cash flow.
- Renovations and Improvements
Properties Undergoing Renovations: Buildings that have recently undergone or are planning significant renovations or improvements are strong candidates. The study can include these costs and accelerate the depreciation of new components.
Component-Specific Renovations: If specific components of the building, such as HVAC systems, lighting, or landscaping, have been upgraded or replaced, these can be separately identified and depreciated over shorter periods.
- Industry-Specific Considerations
Specialized Properties: Certain industries, such as healthcare, hospitality, and manufacturing, often have buildings with specialized components. For example, hospitals have specialized equipment and infrastructure that can be depreciated more quickly. These industries typically derive significant benefits from cost segregation.
Summary
A good candidate building for a cost segregation study typically features a high purchase price or construction cost, recent acquisition or significant renovations, and long-term ownership intentions. Owners of commercial and residential rental properties, particularly in specialized industries, can significantly benefit from the accelerated depreciation and resulting tax savings. Careful consideration of these factors ensures that the property will yield substantial financial advantages from the study. Please reach out to your Miller, Cooper & Co., Ltd. or Specialty Tax Solutions representative for more information related to cost segregation analysis.
Contact Brandon French, Miller Cooper Principal from our Real Estate group with any questions.
