What is Cost Segregation?
By reclassifying assets, bonus depreciation optimization frees up substantial cash flow.
The Cost Segregation study is a guide for commercial property owners. It tells you what you can depreciate and when, and it can be submitted to the IRS as support for your depreciation schedule, which is submitted with your tax returns.
As the property owner, you will be able to claim standard depreciation, which will be spread out over 39 years by default. Depending on the time of year you purchase your property, your deductions may be limited to a portion of the depreciation for a single year, which provides little tax benefit to you as the owner. You can collect Bonus Depreciation, or Accelerated Depreciation if the assets qualify based on the current IRS tax codes. Current regulations limit qualifying assets to those with a depreciation of 20 years or less.
What Assets Qualify for Accelerated Depreciation?
LAND
No Depreciation
The land will not qualify for any depreciation because there is no depreciation on the actual dirt.
COMMERCIAL STRUCTURE
39 Year Depreciation
The structure is an asset that is depreciated using the straight line method and it does not meet the requirements for accelerated depreciation.
MULTIFAMILY STRUCTURE
29 Year Depreciation
The structure is an asset that is depreciated using the straight line method and it does not meet the requirements for accelerated depreciation.
LAND IMPROVEMENTS
15 Year Depreciation
Just about anything that you do to a piece of land is an improvement. Improvements that help the land serve other purposes can be depreciated over 15 years instead of 39 which means they qualify for accelerated depreciation. The land doesn’t need those improvements, but buildings erected on it do, so they’re depreciable to the extent that they support building. Good examples include parking lots, side walks, swimming pools. They are for the buildings, not the land.
INTERIOR FINISHES
5 Year Depreciation
A lot of the finishes on a property have a useful life of 5 years and they can be depreciated accordingly. This includes carpets, outlets, baseboards, appliances, fire extinguishers, and more. Unfortunately, if you upgrade the carpet and install tile floors, they are going to become part of the structure and they wont qualify for the bonus depreciation of this asset class.
FURNITURE
7 Year Depreciation
Depreciation on Furniture is defined as the reduction in the value of furniture due to its continuous use over time and the wear and tear caused throughout its useful life. Furniture items are any movable asset used to make any room, office, or factory a convenient and desirable workplace. Depreciation on furniture is a part of furniture cost price, charged as an expense in an accounting period. This is because with every passing year, the value of the furniture items depreciates and its resale value decreases. This concept of depreciation, however, is normally applicable for the furniture pieces used for commercial purposes.
Let's Calculate Your Potential Savings
We will utilize some averages to create a potential scenario that would mirror a real world investment. Let’s assume we bought an apartment complex for $5,000,000. By default we would be depreciating that over 29 years. With a Cost Segregation Study, we find out the following:
We find the 5 YEAR ASSETS are worth
$500,000
We find the 15 YEAR ASSETS are worth
$1,500,000
We find the STRUCTURE is worth
$2,000,000
which is depreciated over 29 years
We find the LAND is worth
$1,000,000
Any class with a life under 20 years can be depreciated in year 1.
This year the bonus depreciation dropped to 80% from 100%, so you would get a total depreciation of $1,600,000 + $68,965 ($2,000,000/29 Years) for the property.
Then you multiply that by your ownership to get your share of the depreciation that will show up on the K-1.
Then you multiply that by your Federal and State income tax percentage.
If you are at 35% for your federal tax and have no state tax, it would look like this:
$1,668,965 * 20% ownership =
Passive Loss
$333,793 * 35% Federal Tax Bracket =
Income Tax Savings