Cost Segregation Studies: 3 Ways to Get the Biggest Benefit

September 29, 2017

Cost segregation studies are popular with real estate owners looking for big, front-end tax deductions.

The studies let commercial and multi-family property owners take advantage of shorter depreciable lives, accelerating their depreciation expense. They might even be able to take bonus depreciation on these assets, which would make their first-year deduction even bigger.

It sounds great, right? In many cases, it is. But timing is everything. You must coordinate proper planning with your tax adviser to ensure that the additional depreciation from a cost segregation study will result in actual tax savings.

Keep these three considerations in mind to get the most financial bang out of your study.

1. Return on Investment

The value of a cost segregation study is that it accelerates depreciation that would otherwise occur later. So, you’re reaping the benefit of the time value of money.

That’s the simple idea that money available now is worth more than the same amount later.

The longer you hold a property after a cost segregation study, the larger the time value of money. Conversely, when you sell within a few years of a cost segregation study, you are limiting your benefit. In fact, the cost of the study could exceed the benefit if you sell too soon.

Here’s a good rule of thumb. If you plan to keep a property for at least five years, then it’s a good candidate for a cost segregation study.

2. Tax Bracket

It is true that a cost segregation study can produce a large deduction. But a deduction is only as good as your tax bracket.

So, if you’re in a federal tax bracket of 10 percent, the maximum federal tax savings available is 10 cents per dollar. If you’re up in the 39.6 percent range, your maximum federal tax savings is now almost 40 cents per dollar.

Be sure to perform the cost segregation study when your marginal tax rate is as high as possible.

3. Recapture

Cost segregation studies convert real property into tangible property. But when you sell tangible property, the IRS requires you to pay taxes at the ordinary rate on any depreciation claimed the year of your study. This recapture consideration is another reason to time your study with your tax bracket, so that the tax you pay with recapture isn’t higher than the deduction you receive with your cost segregation study.

The Bottom Line

Cost segregation studies are a smart tax planning tool. But you can lose potential tax savings if you don’t plan properly.

Before considering a cost segregation study, sit down with your tax preparer and go through these considerations to make the deduction work for you.

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