Real estate owners utilize cost segregation studies to capture significant tax benefits.

• Author: Kimmel, Matthew G.

Real estate owners and investors can use cost segregation studies to accelerate overall property depreciation, which can produce a current income tax benefit. This tax benefit applies to commercial, industrial, multifamily, and special purpose real estate. Typically, the more specialized and costly the property, the greater the tax benefits. Often, these benefits are neither captured nor maximized by many real estate owners, because they neglect to have a cost segregation study done on their property.

Cost Segregation Study

A cost segregation study is a comprehensive analysis of the total cost or value of building and site improvements. Cost segregation studies typically do not include analyzing the value of land, furniture, fixtures, and equipment. These studies apportion the value or cost of all specific components of the building and site improvements to certain specific federal tax depreciable life categories. To optimize the reclassification from longer lives to shorter lives, a detailed analysis of the property is required. Qualified engineers and appraisers typically perform these analyses. An understanding of specific tax guidelines and regulations, tax court cases, revenue rulings, and current legislation is required to conduct such studies. Cost segregation studies should be utilized for any taxpayer who constructs a building, acquires a property, expands an existing facility, or changes the tax basis of real property. In addition, cost segregation studies can be conducted on properties constructed or acquired in the past, even if no cost segregation study was performed at the time the property was placed in service.

Methodology

Generally, cost segregation methodology requires establishing a complete and thorough understanding of the total cost or value of the real estate asset in order to determine the total depreciable tax basis. Accomplishing this requires a detailed accounting of the cost of land, site 'improvements, buildings, and equipment in use at the real estate. In new construction, further details of construction cost information, both direct and indirect, are typically utilized for the building. "Direct costs" are costs for labor and materials necessary to construct the asset. "Indirect costs" are items that are required for the project, but not directly associated with specific labor and materials. Some examples of indirect costs include architectural and engineering design fees, contractor overhead and profit, permit...