How a Cost Segregation Study Could Help You Save on Taxes and Improve Cash Flow

by Kevin Kalal, CPA, MBT

If you’re considering purchasing or have purchased a building within the last few years, it’s possible you could benefit even more from your acquisition. Sure, there are plenty of ways you could accomplish this. But one increasingly popular—and effective—tactic is to conduct a cost segregation study.

Performed by tax experts and engineers, cost segregation studies offer commercial and residential building owners a powerful opportunity to accelerate depreciation. The result: a substantial tax savings and instant cash flow influx. Now, thanks to the expanded bonus depreciation provision included in the Tax Cuts and Jobs Act (TCJA), cost segregation studies may be more beneficial than ever before.

Here are a few things to know about them:

What are the primary benefits of a cost segregation study?

A cost segregation study is essentially a service that allows building owners to deduct depreciation earlier. (In case you were wondering—yes, it’s approved by the IRS.) The study involves analyzing the components of a building and reclassifying certain items such as flooring, cabinetry, furniture, appliances, fixtures and land improvements, to name a few, to depreciate over 5, 7 or 15 years.. and possibly even 1 year!  Whereas generally buildings are depreciated over 27.5 or 39 years.. By accelerating the depreciation deduction of certain assets, building owners often gain both tax savings and cash.

How has the TCJA made cost segregation studies even more beneficial?

Prior to the TCJA, bonus depreciation, which allows taxpayers to depreciate a certain amount of eligible business property during the asset’s first year in service, applied only to new property. What’s more, taxpayers were able to depreciate only up to 50% of the property’s cost.

The TCJA revised bonus depreciation to include used property acquired after September 27, 2017. The new tax law also increased the depreciation amount to 100% of the property’s cost during its first year. At the moment, the bonus depreciation amount is set to decrease to 80% in 2023, 60% in 2024, and so on.

Cost segregation studies identify property components of the original purchase which will qualify for bonus depreciation. For instance, we had a client who purchased a building for $800,000 few years ago. As a result of a subsequent cost segregation study, we were able to identify property, with shorter lives of around $200,000.  We were able to depreciate this full amount using bonus depreciation. These additional depreciation deductions were available the year the cost segregation study was completed and greatly reduced taxes and improved cash flow.

When should you consider a cost segregation study?

Cost segregation studies are most beneficial to owners who have purchased a building within the last few years and typically the purchase price was $500,000 or more. If that describes your situation, or if you’re planning to purchase a building in the near future, a cost segregation study could be worth your while.

Could you benefit from a cost segregation study?

If you think you could benefit from a cost segregation study, now is the time to act. As I mentioned, the full (100%) benefit of bonus depreciation will expire after tax year 2022. A good first step is to check in with your tax advisor. Our team of real estate and construction CPAs is here to help determine if it makes sense for you to conduct cost segregation study, and, if so, guide you through next steps. If you have questions or would like to learn more, contact us today.