When conducting a Cost Segregation Study, there are some key differences between newly constructed buildings versus previously acquired buildings to be aware of. You may have purchased a property years ago that was a primary residence, and now you’ve placed it in service as a rental. While this is entirely normal, it may present some challenges. In this blog, we will cover some of the differences and challenges between these two types of properties.
Cost Segregation for NewCon Properties
New properties present some of the best opportunities for cost segregation due to the nature of their construction and the availability of detailed cost records.
1. Fresh Documentation and Detailed Cost Breakdown
If you recently built a property and hired a general contractor, you likely will have documentation from them that lists exactly what was paid and what portion was allocated to each structural classification. These documents are commonly referred to as a G-702/703, and they provide our engineering team with the detail needed to create an accurate Cost Segregation Report.
Another item we look for with a newly constructed building is construction drawings. A complete set of drawings will include a cover page, general plans, demo plans, and civil, structural, architectural, mechanical, plumbing, and electrical drawings. While not every build will have a complete set, any drawings will provide useful information for us to complete your study.
2. Potential for Large-scale Improvements
Newly built properties tend to have a higher number of assets that qualify for accelerated depreciation, such as specialized lighting, HVAC systems, land improvements, and high-end finishes. These items can be classified under personal property and depreciate over 5, 7, or 15 years. All these components contribute to a larger upfront deduction, allowing for more significant tax benefits.
3. Immediate Cash Flow Boost
Accelerating depreciation on a new property can provide immediate tax relief. The initial years after purchasing a property are often crucial for cash flow management. By leveraging cost segregation, property owners can offset initial operating expenses with larger depreciation deductions, effectively lowering their taxable income and boosting cash flow.
Cost Segregation for Existing Properties
While newly constructed properties have some advantages, a Cost Segregation Study can still be beneficial for an existing property with or without improvements being made.
1. Possible Limited Documentation
Let’s say you purchased a property and lived in it as your primary residence for 10 years. During those 10 years, you made some minor improvements and maybe some major improvements. You may have invoices for the work done, but these are all individual. Unless you keep good records of everything done, it can be difficult to go back and put together an itemized list of the work done over the years. Although it still can be done, it will take some work and digging to make it accurate.
2. Catch Up on Missed Depreciation (Cost Segregation Study on Acquired Properties)
One of the unique advantages of cost segregation for existing properties is the ability to “catch up” on missed depreciation. If you’ve owned a property for several years and never conducted a cost segregation study, you can still benefit by applying accelerated depreciation to prior years. A cost segregation study allows you to adjust your depreciation schedule and retroactively claim missed deductions for the previous years you’ve owned the property, which can result in a significant tax refund.
Additionally, the retroactive depreciation is beneficial if the property has undergone substantial improvements or renovations during your ownership. By segregating costs related to the improvements, you can claim additional deductions that might have been missed in previous tax years.
3. Property Already Listed on a Fixed Asset Report
For properties that have been owned for many years, a Fixed Asset Report may already exist for your property. The Fixed Asset Report is a tax document that details out the basis for the building, land, and any improvements done to the property. This provides us with useful information to start your Cost Segregation Study as well as create a Benefit Estimate for you. Things like the useful life of the building, the type of depreciation taken, as well as the amount of depreciation you have accumulated over the years since it was placed in service.
Depending on how much depreciation has already been claimed, the remaining depreciation benefits may be less than they would be for a brand-new property. However, applying a Cost Segregation Study could still uncover opportunities for reclassifying some assets that have been missed in the original depreciation schedule.
Conclusion
Whether you’re dealing with a newly constructed property or an existing property, we will work with you to determine the best way to attack your Cost Segregation Study. Ultimately, the key to unlocking the full potential of cost segregation—regardless of the property type—is understanding the specific characteristics of the property and working with qualified professionals to conduct a thorough study.
Join Us!
Sign up for our free Cost Segregation 101 webinar on February 11th at 10:04 PST: Increase your Cash Flow
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Edited by Randy Eickhoff, CPA, Founder & Head Coach at Acena Consulting. Photo courtesy of Goran Has on Flickr.
