The benefits of cost segregation studies

Your Guide to State, Local, Federal, Estate + International Taxation

Have you recently purchased a building? Have you done any build-out work on an existing building? Have you recently remodeled? Are your leasehold improvements properly classified for tax purposes? Are you looking to enhance your cash flow? If you answered yes to any of these questions, then you may benefit from having a cost segregation study performed.

A cost segregation study captures all the costs associated with a building or building improvement and breaks them out into their appropriate personal or real property classification. As a result of the cost segregation study, a business owner can depreciate the personal property over a shorter period of time (5, 7 or 15 years) and benefit from the deductions up front rather than allowing the total construction cost to be depreciated over the life of a building, which is 39 years. The tax savings generated by depreciating more assets as personal property usually more than make up the extra cost incurred in conducting the study.

Completing a cost segregation study generally involves professional engineers reviewing blueprints and AIA payment application forms. The engineers review all the costs associated with the building or building improvement. Costs are broken out into various categories:

  • Indirect costs – architect fees, interior design fees, engineering costs and other miscellaneous construction costs
  • Direct costs related to personal property – machinery and equipment and furniture and fixtures
  • Direct costs related to real property – building, fire protection and alarm systems, flooring, doors and HVAC system

The goal for the cost segregation study is to identify costs related to real property that can be reallocated to short-life personal property. An example of this could be identifying electrical or plumbing costs that may be related to the operation of machinery and equipment, which is generally depreciated over five years.

Once the real property costs are reallocated, the final step is to allocate the indirect costs to the personal and real property buckets. Again, the end result is an allocation that provides a significant portion to personal property that can be depreciated over 5, 7 or 15 years. This reallocation of costs ultimately provides greater cash flow to the business owner by reducing the overall tax burden.

Have questions? Our tax professionals help clients in a variety of industries including construction, dealerships, restaurants, technology and more.

Kelly Lynch, CPA