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Cost Segregation and Its Benefits to Real Estate Investors

Posted on April 09, 2018 by Jeff Hobbs

A responsible investor makes sure that they are on top of their tax obligations. If you have real estate properties, it’s important that you identify assets and costs to be able to classify assets for tax purposes. This is called cost segregation.

What is cost segregation?

According to experts, cost segregation is a crucial tax strategy that could generate cash-flow in real estate investing. What this process does is to look at a depreciable real estate property as land improvements and personal property elements, not only as a building and land.

Before 1981, real estate investors were allowed by the IRS (Internal Revenue Service) to break their depreciable assets into components. This “componentization study” is for investors to qualify for a credit known as the “investment tax credit,” which is defined in Section 38 of the Internal Revenue Code. During that time, it was a common practice to identify the personal property that was built into or attached to a depreciable property.

How does cost segregation benefit real estate investors?

Nowadays, a cost segregation study is crucial as it helps investors in real estate to determine the assets in a building’s acquisition or construction with a depreciable life that can be lessened to 5, 7, or 15 years.

Once the assets are identified, the cost associated with them are then classified to help the owner accelerate the depreciation of the property in question for tax purposes.

Rather than wait until a real property reaches its depreciable life, which is 39 years, depreciation can happen sooner by segregating the cost of the four components, namely, personal property, building, land, and land improvements, and accelerate depreciation on part. This allows taxpayers to have cash flow savings simply through decreased distributions, which are essential in covering investors’ income tax liabilities.

For example, if an asset has a value of $400,000, each $100,000 of that asset can be reclassified to a 5-year recovery period, instead of the 39-year recovery period. Assuming a 5% discount rate and a 35% marginal tax rate, there will be a net-present-value savings of $16,000.

Aside from decreasing the depreciable life of an asset, the double-declining balance method may also be used for personal property, generating the most tax benefits. This method takes into account carpeting, furniture pieces, fixtures, equipment, and window treatments, to name a few.

On the other hand, sidewalks, fences, landscaping, and paving are used in the land improvement category. All land improvements will have a 15-year recovery period on the 150% declining balance method. Using the straight-line method, all costs associated with the building structure will have a depreciable life of at least 39 years.

How to find the best cost segregation specialist?

A cost segregation study is no walk in the park. For this reason, it’s recommended that a taxpayer who is into real estate investing looks for an expert should they want to enjoy the benefits of segregating costs.

Here are some tips to help you find the best candidate.

1. Conduct a thorough search.

To find a qualified cost segregation specialist, you must know where to look.

First, search the internet for local agencies that provide such service. But make sure you are not talking to a middleman. Second, find out how long they have been in the business of providing cost segregation studies. How many studies have they delivered successfully?

2. Find out if they employ engineers.
Cost segregation involves classifying components of real estate properties. Because of this, a cost segregation study would only be legitimate if the provider works with licensed engineers who are experts in construction, engineering, and cost estimation.

3. Ask if they have tax experts.
Accountants with enough experience in taxation and accounting are also essential in this project. To produce quality output, the cost segregation expert will need to employ accountants and tax experts to ensure that they are on top of the ever-changing tax rules and precedents.

4. Ask for work samples.
Cost segregation reports need to be detailed for you to understand how they have come up with such computations. Reports should also conform to the IRS’ requirements should you be audited. See to it that the sample works shown to you by the cost segregation specialist is as detailed as possible.

5. Know about their fees.
There’s no standard rate for cost segregation fees. Make sure you compare fees from at least three different agencies. However, don’t settle for the cheapest one. Be sure to compare the quality of their services to know which one is the best.

Final tips

Contact Segregation Holding to get to know more about a company that has dedicated its time and resources to providing top-notch cost segregation services. We have 59 well-trained engineers and architects who will help ensure that they deliver according to or even exceeding client expectations.

We also have staff members who are experts in construction, civil engineering, and architecture, as well as accounting. Give us a call today at 972-865-9050.