Utilizing Cost Segregation to Enhance Investment Real Estate Cash Flow
Everyone knows that a dollar today is more valuable than one received in ten years. Tweed Financial Services, Inc. suggests that a Cost Segregation study, which reviews the depreciation schedules related to your real estate investments, may reduce your taxable profits and thereby enhance your after-tax cash flow.
Certain assets may qualify for classification as tangible personal property, which can be depreciated over a five to seven-year life. Therefore, Cost Segregation studies can produce substantial savings because depreciation is shifted to the earlier years of the building’s depreciated life, thus increasing their present value.
While costs such as office equipment and furniture are easily recognizable as personal property, construction-related costs that are often included as part of real property may also qualify for a shorter depreciable life.
For example, the 1997 Hospital Corporation of America ruling by the Tax Court allowed the assignment of a five-year depreciable life to a number of building improvements, such as primary and secondary electrical distribution systems and vinyl wall and floor coverings.
To segregate costs first requires an engineering-based study to determine reallocation of real property to personal property. Although the expense associated with this previously made it feasible only for multi-million dollar properties, the proliferation of providers has made it worthwhile for properties over $750,000.
In order to benefit from Cost Segregation, an individual should own a property constructed, acquired or improved within the last 15 years. Even if the property has been sold, there may be benefits.
If you are considering a Cost Segregation study, the first step is to consult your tax advisor for an initial evaluation. If you approve the results, then a team of construction engineers and CPAs work together to develop a list of assets that qualify for accelerated depreciation and to determine each asset’s depreciable life.
Finally, a change of accounting method is filed so that the depreciation schedule can be adjusted. Note that a Cost Segregation study requires a thorough knowledge of IRS regulations and tax rulings, as well as Senate reports and expertise regarding building costs and engineering reports.
As is true for all property-related decisions, the owner must consider the disadvantages associated with a Cost Segregation study. Although it is deductible as a business expense, the price of the study may outweigh the benefits of accelerated depreciation.
In addition, if the property is sold, depreciation recapture provisions will be triggered. Furthermore, should the property be involved in a Section 1031 exchange, a Cost Segregation study will also be required for replacement property.