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  • Connor Quinn

Uncovering Hidden Tax Savings in Real Estate: The Benefits of Cost Segregation Studies

As a real estate investor, I have always been on the lookout for ways to maximize my profits. One strategy that I have found to be particularly effective is cost segregation studies.In this article, I will explain what cost segregation studies are, when you should consider them, how to get started, the cost segregation study process, and the tax benefits of cost segregation studies. I will also provide a case study to illustrate how cost segregation studies can lead to tax savings, and discuss the future of cost segregation studies in real estate.




What is a Cost Segregation Study?


A cost segregation study is a process that allows real estate investors to identify and reclassify assets in order to accelerate depreciation and reduce their tax liability. In other words, it involves separating a property's assets into different categories for tax purposes. This can result in significant tax savings, as certain assets can be depreciated over a shorter time period, which means a higher tax deduction in the early years of ownership.


Cost segregation studies are typically performed by professionals who have experience in accounting and engineering. They will analyze the property's assets and determine which ones can be reclassified. This process can be complex and time-consuming, but the benefits can be substantial.


When Should You Consider a Cost Segregation Study?


Cost segregation studies are most beneficial for owners of commercial or residential rental properties. The study is most effective when the property has been recently acquired, constructed, or renovated. This is because the study can identify assets that may have been overlooked during the initial purchase or construction phase, and those assets can be reclassified for tax purposes.


It is also important to consider a cost segregation study if you are planning to hold onto the property for a long time. This is because the benefits of the study are realized over the life of the property. The longer you hold onto the property, the more tax savings you will see.


How to Get Started with a Cost Segregation Study


The first step in getting started with a cost segregation study is to find a qualified professional who has experience in accounting and engineering. This can be a CPA, an engineer, or a firm that specializes in cost segregation studies.


Once you have found a professional, they will conduct a feasibility study to determine whether a cost segregation study is appropriate for your property. This will involve analyzing the property's assets and determining whether there are enough assets to justify the cost of the study.


If the feasibility study shows that a cost segregation study is appropriate, the professional will then conduct the study itself. This will involve analyzing the property's assets in detail and reclassifying them for tax purposes.


The Cost Segregation Study Process


The cost segregation study process typically involves the following steps:

1. Site Visit: The professional will visit the property to gather information on its assets, take measurements, and take photographs. 2. Asset Identification: The professional will identify all of the assets on the property that can be reclassified for tax purposes. 3. Asset Valuation: The professional will value each asset and categorize them based on their useful life and depreciation schedule. 4. Reporting: The professional will provide a detailed report outlining the reclassified assets and the resulting tax savings.


Tax Benefits of Cost Segregation Studies


The tax benefits of cost segregation studies are significant. By reclassifying assets, the property owner can accelerate depreciation and reduce their tax liability. This can result in significant tax savings in the early years of ownership.


For example, let's say you own a commercial property with a cost basis of $1 million. Without a cost segregation study, you would be able to depreciate the property over 39 years. This would result in an annual tax deduction of approximately $25,641.


However, if you were to conduct a cost segregation study, you may be able to reclassify certain assets, such as carpeting, lighting fixtures, and HVAC systems, as personal property. These assets can be depreciated over a shorter time period, such as 5 or 7 years, resulting in a higher tax deduction in the early years of ownership.


How Cost Segregation Studies Can Lead to Tax Savings


To illustrate how cost segregation studies can lead to tax savings, let's look at an example.

John owns a residential property with a cost basis of $2 million. He decides to conduct a cost segregation study and finds out he can reclassify $500,000 worth of assets to a 5 year depreciable life. If the study wasn’t done, the depreciation expense would be around $72,727 a year ($2,000,000 / 27.5). With the cost segregation study and finding out that $500,000 worth can be depreciated over 5 years, he can claim a depreciation deduction of $154,545 (($1,500,000 / 27.5)+($500,000 / 5)). As a result, he is able to accelerate depreciation on those assets and claim an additional deduction of $81,818 in the first 5 years. Assuming a 24% tax rate, Bob is able to save a total of $19,636 a year (or $98,180 over 5 years) more in taxes because he used a professional to perform the cost segregation study.


This is just one example of how cost segregation studies can lead to significant tax savings. The actual savings will depend on the property's cost basis, the assets that are reclassified, and the depreciation schedule used. Always remember to factor in land and back that out of the contract price if you are evaluating a rental property for cost segregation purposes.


The Future of Cost Segregation Studies in Real Estate


As the benefits of cost segregation studies become more widely known, we can expect to see more real estate investors taking advantage of this strategy. In fact, the Tax Cuts and Jobs Act of 2017 has made cost segregation studies even more attractive by allowing 100% bonus depreciation for certain assets.


In addition, advances in technology are making cost segregation studies more efficient and cost-effective. For example, some firms are now using drones to conduct site visits and gather data on a property's assets.


Cost segregation studies are a powerful tool for real estate investors who want to maximize their profits and reduce their tax liability. By reclassifying assets, investors can accelerate depreciation and increase their tax deductions in the early years of ownership. If you own a commercial or residential rental property, it is definitely worth considering a cost segregation study to see if it makes sense for your situation.

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