Maximizing Deductions with Cost Segregation Studies

Cost segregation studies

Want to reduce tax liability and increase cash flow? You’re in the right place. Maximizing your tax deductions is a smart way to start saving. Thought you’ve cashed in on all available deductions? Think again. Enter cost segregation studies.

Cost segregation is a strategic tax planning tool that allows businesses to identify and reclassify parts of their buildings, such as fixtures, plumbing, or landscaping, to accelerate depreciation deductions. By categorizing these components differently, businesses can depreciate certain assets over shorter periods (5, 7, or 15 years) instead of the standard 27.5 or 39 years for buildings. The results? Significant tax savings and improved cash flow.

Not quite sure what this means? Let our CPAs explain.

Understanding Cost Segregation Studies

When you own a building, not all parts have to be treated the same for tax purposes. Cost segregation studies help identify parts of your building that can be depreciated faster than the building itself. Depreciation spreads the cost of an asset over its useful life, acknowledging that assets deteriorate and lose value over time. By accelerating depreciation on certain components, you can take larger tax deductions sooner, reducing your taxable income and saving your business money. In this article, we’ll delve into cost segregation studies and how you can maximize your deductions while staying compliant.

Conducting a cost segregation study involves a detailed analysis by professionals such as engineers and tax experts who identify and reclassify parts of the building that can be depreciated over shorter periods. This is typically done for assets such as tangible personal property, land improvements, and certain building components like electrical systems, Heating, Ventilation, and Air Conditioning (HVAC), and interior finishes. By reclassifying these assets, your business can optimize depreciation deductions and enhance financial performance.

In addition to reducing your taxable income, you also increase your immediate cash flow. This offers greater financial flexibility, allowing you to reinvest in business operations or pursue new investments.

Eligibility and Considerations for Cost Segregation Studies

While the benefits are great, not all properties qualify for cost segregation. Typically, properties that benefit most include those that are newly constructed, recently purchased, or significantly renovated. 

To determine if a property is suitable for a cost segregation study, you need to consider several factors:

  1. Overall cost. Properties with a higher overall cost are more likely to benefit from cost segregation. Greater value translates to bigger savings.
  2. Type of property. Commercial properties, manufacturing facilities, retail spaces, and office buildings are ideal candidates. Why? The buildings often use more aesthetics that depreciate faster.
  3. Components that can be reclassified. Buildings with significant non-structural elements, such as specialized electrical and plumbing systems, and custom fixtures have more components that can be reclassified. This means greater potential tax savings.

An equally important consideration of the benefits would be looking into the potential tax implications. One such consideration is depreciation recapture, which can impact future tax liabilities when the property is sold. Depreciation recapture occurs when the IRS taxes the gain on the sale of depreciated property, potentially increasing your tax burden at the time of sale. This means that your profits at the point of sale will be considered higher on a greatly depreciated building value. Therefore, it is important to consult with an experienced accountant and take into account your long-term business plans, especially as they relate to the building from which you operate.

Conducting a Cost Segregation Study

Conducting a cost segregation study involves several key steps to ensure accuracy and compliance, leading to significant tax savings.

  1. Conduct a feasibility study. Identify all qualifying assets and reclassify parts of your building, such as fixtures, plumbing, and electrical systems, to capture every possible depreciation opportunity and determine the feasibility of cost segregation depreciation.
  2. Consider your long-term plan and financial position. Assess your business’s future plans and current financial standing to understand the impact of cost segregation on your broader business objectives. This step is crucial to avoid higher capital gains tax implications in the future.
  3. Appoint a specialist. Choose a reputable CPA to ensure accuracy and compliance, helping you avoid potential issues during an IRS audit.
  4. Incorporate cost segregation into your overall tax plan. This will help you optimize all possible deductions for greater tax efficiency and savings.

Compliance and Reporting Requirements

Ensuring compliance with IRS guidelines and accurately reporting the findings of a cost segregation study is crucial to avoid potential issues and maximize tax benefits.

Tips to ensure reporting accuracy and transparency in the event of an audit:

  1. Accurately report the reclassified assets. All reclassifications must reflect correctly in your financial statements and tax filings.
  2. Maintain substantial records. Keep thorough documentation of the cost segregation study, including reclassification of assets.
  3. Disclosing cost segregation study findings. An approved professional should always perform the study. They will document the findings in a manner that is tax-compliant. 

Cost segregation is a powerful tool for businesses, but can also be advantageous for individuals who own rental properties or have made significant improvements to their real estate assets.

At Fusion, our CPAs can advise on the viability of cost segregation studies for you. Additionally, we take your financial profile into account and look at where you can optimize deductions while ensuring compliance with IRS requirements for your business. Whether it is depreciation calculations or a long-term tax savings strategy that you require, we can assist you. Contact us today!

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This blog article is not intended to be the rendering of legal, accounting, tax advice, or other professional services. We base articles on current or proposed tax rules at the time of writing and do not update older posts for tax rule changes. We expressly disclaim all liability regarding actions taken or not taken based on the contents of this blog as well as the use or interpretation of this information. Information provided on this website is not all-inclusive and such information should not be relied upon as being all-inclusive.