Skip to Main Content

Cost Segregation - Decreasing taxes and increasing cash flows

02/20/2020

Brian And Melissa

By:
Brian J. Bauer, B.A., M.B.A., J.D., LL.M. (Tax), General Counsel
Melissa Bailey, Controller

At Legacy Development & Consulting Company, LLC, we continually seek the best outcomes for our investors. One opportunity which helps us achieve this goal is “cost segregation”—a tax planning technique which separates the various components of a real estate project and re-classifies assets in order to qualify for shorter depreciation periods, accelerated depreciation and the new bonus depreciation under the Tax Cuts and Jobs Act of 2017. We’ve completed this process with several properties in the Legacy portfolio, with the remaining properties scheduled to be completed in the very near future. This process can be complicated, but it can be tremendously advantageous to investors in real estate projects.

Cost segregation is the process of analyzing a commercial real estate project in order to identify assets that are eligible for shorter depreciation periods and accelerated and/or bonus depreciation. To conform with existing tax laws and accounting rules, cost segregation seeks to reclassify personal property assets and land improvements that are otherwise grouped with real property assets and to separate these items out for tax reporting purposes. By shortening depreciation periods and taking advantage of accelerated depreciation and/or bonus depreciation current income tax obligations are decreased and cash flows are increased from real estate operations. 

A cost segregation study generally identifies and segregates assets in a real estate project into the following four distinct asset class categories:

Personal Property:  furniture, removable fixtures, floor coverings, window treatments, cabinets, countertops, shelving, etc.; depreciable over either 5 or 7 years; qualifies for accelerated depreciation; bonus depreciation available. 

Land Improvements:  sidewalks, walkways, parking lots, landscaping, pools, tennis courts, etc.; depreciable over 15 years; qualifies for accelerated depreciation; bonus depreciation available.    

Buildings and Structural Components:  HVAC systems, wiring, plumbing, some types of lighting fixtures; depreciable over 27.5 years (residential real property) or 39 years (non-residential real property); straight-line depreciation.  

Land:  non-depreciable. 

By reclassifying assets from non-depreciable land to depreciable land improvements, and by segregating personal property assets from real property assets, the taxpayer is able to increase non-cash deductions for depreciation, thereby deferring the payment of income taxes and increasing cash flows from real estate operations. As an added benefit, a properly performed cost segregation study may also present an opportunity to reduce real estate tax liabilities on the local level.   

A cost recovery study can be undertaken: (a) upon the acquisition of an existing property; (b) when a previously-acquired property is renovated or expanded; (c) on newly-constructed property; or (d) as a “look-back” analysis of property purchased in a previous tax year.  A proper cost segregation study will create supporting documentation which will withstand scrutiny in the event of an IRS audit.

The use of a third-party, cost segregation analyst with significant experience and expertise in cost estimating and allocations and a workable knowledge of applicable state and local laws is generally recommended in order to avoid understatement penalties which may be imposed on taxpayers who use cost segregation too aggressively.   

Cost segregation is only one of many tools we use to increase returns and enhance the investment experience for our investors. The interests and financial well-being of our investors are always of paramount importance and remain our focus. We continuously explore all available avenues for the acquisition, placement and management of the assets in our portfolio, always putting the interests of our investors first.