Benjamin T. Dyches, DDS, JD
The TaxRx Group is a specialty tax consulting firm. We work with local accounting teams to identify advanced options that reduce our clients’ taxes. We produce a yearly tax prescription (Tax Rx) to maximize available benefits and savings.
This week’s Tax Tip is an introduction to Cost Segregation. When done correctly, Cost Segregation can be one of the best tools to reduce your tax liability.
Cost segregation is an IRS-endorsed means of calculating depreciation. This technical process separates short-life from long-life items, often doubling or tripling depreciation during the first five years of ownership.
The results are even better for assets acquired from September 28, 2017, to December 31, 2022. During this period, all short-life assets (<20-year depreciation lives) can be depreciated during the first year of ownership (bonus depreciation). Real estate investors who depreciate 20 to 50% of the total purchase prices may see tax savings that cover 33% to 66% of the downpayment. Bonus depreciation ends on December 31, 2022.
What is Cost Segregation?
Cost Segregation is a commonly used strategic tax planning tool that allows companies and individuals who have constructed, purchased, expanded, or remodeled any kind of real estate to increase cash flow by accelerating depreciation deductions and deferring federal and state income taxes.
What is a Cost Segregation Study & How Does it Work?
When a property is purchased, not only does it include a building structure, but it also includes all of its interior and exterior components. On average, 20% to 40% of those components fall into tax categories that can be written off much quicker than the building structure. A Cost Segregation study dissects the construction cost or purchase price of the property that would otherwise be depreciated over 27 ½ or 39 years. The primary goal of a Cost Segregation study is to identify all property-related costs that can be depreciated over 5, 7 and 15 years. For example, certain electrical outlets that are dedicated to equipment such as appliances or computers should be depreciated over 5 years.
Cost Segregation – Supercharged by 2017 Tax Cuts and Jobs Act
Cost segregation has been very attractive to real estate investors. The 2017 TCJA magnified the benefits by allowing ALL 5-, 7-, and 15-year life properties to be depreciated in year one. Therefore, it is typical for 20 to 50% of the total cost of the real estate to be depreciated in year one.
Examples Before and After 2017 Jobs Act
Let’s consider a standard commercial office building with a depreciable basis of $4,000,000 purchased in September of 2019. The investor is in the 37% tax bracket. Before the Tax Cuts and Jobs Act, the depreciation resulting from a cost segregation study would have looked like that shown in Table 1.
The use of a cost segregation study would have significantly enhanced the taxpayer’s tax and cash flow position as seen in Table 2.
After the passage of the Tax Cuts and Jobs Act of 2017, and with the utilization of cost segregation, take a look at the difference in Table 3. Over $1.1 million in additional depreciation in year one.
If you think you may benefit from cost segregation, call us at 801-477-7525 or schedule an appointment to speak with one of our TaxRx experts here.