By Fred Solomon, CPA and Managing Partner and Giancarlo Laguercia, CPA & MST
WHAT IS COST SEGREGATION?
If you own real estate you need to know about cost segregation. Cost segregation is a tax deferral strategy that generates immediate tax savings and thereby increases cash flow for real property owners. The strategy works by frontloading depreciation deductions into the earlier years of ownership. Buildings are typically depreciated over 27.5 or 39 years depending on whether they are residential or commercial property. However, the tax law allows certain assets to be depreciated faster. Cost segregation involves the detailed analysis of the properties components to determine what assets qualify for shorter class life depreciation into 5, 7 or 15 years for tax purposes.
WHAT ARE THE BENEFITS OF COST SEGREGATION?
Benefits vary depending on the property basis, property type and other factors such as the taxpayer’s tax rate, but they are often significant. The savings are best illustrated by example.
One of our clients, a real estate investor who owns approximately 30 rental properties (primarily apartment buildings), had $4,000,000 in rental income in 2011. The client needed $4,000,000 in additional rental losses to offset his rental income. By performing cost segregation studies on 4 of the properties, our client was able to generate $4,000,000 in additional depreciation deductions in 2011. These deductions completely eliminated his taxable income and the client paid no income tax in 2011. The four buildings upon which the study was performed had a depreciable basis of approximately $24,000,000. The cost segregation study reallocated approximately $8,000,000 of the $24,000,000 basis to shorter life property. In this case, as in many cost segregation study situations, the law allows the taxpayer to catch-up on the prior year’s depreciation resulting from the reallocation to shorter life assets. As a result, $4,000,000 of the $8,000,000 reallocated became a 2011 tax deduction. A great result for our client.
WHAT PROPERTIES ARE GOOD CANDIDATES FOR COST SEGREGATION?
All types of real estate can be good candidates for cost segregation. Existing rentals, new construction, remodels or properties undergoing significant leasehold improvement can all benefit from cost segregation. Certain types of real estate generally have a higher reallocation to shorter life assets than others. For example, a medical building may be able to reallocate 20% to 40% to shorter life assets whereas a warehouse may only get a 5% to 15% reallocation. Apartments typically have a 15% to 35% reallocation. Every situation and property is unique, therefore, it’s always best to explore the opportunity and determine whether or not your property is a good candidate.
SRG’S APPOACH TO COST SEGREGATION
SRG’S CPA’s and staff have extensive experience with cost segregation. We have been assisting our clients with cost segregation for over 10 years. We work closely with our clients to understand their needs and tax picture to determine what benefits will be obtained from a cost segregations study. We use our expertise in the area to review all aspects of the cost segregation study. We insure that the engineers and professionals who provided the detailed property reports that support the reallocation have obtain the maximum benefits for our clients. We prepare all required tax filings to meet the taxing authorities reporting requirements in this area. In short, SRG takes care of all the details.
The above is not tax advice for any client or matter; it is provided as a topic of general interest to our readers and should not be used for tax planning purposes. Each client’s situation contains unique facts.
If you are interested in exploring how these rules could benefit you, please contact Fred Solomon or Giancarlo Laguercia at (818) 995-0090 or at firstname.lastname@example.org and email@example.com to receive advice on your specific matter.