As we all know, the tax code can be confusing. Despite its growing popularity, there are still a number of misconceptions surrounding the benefits of a cost segregation study. These misunderstandings can lead business owners, real estate investors, and even tax professionals to overlook or misapply the strategy. In this blog post, we’ll address the top five misconceptions about cost segregation and help you understand the information better to make a more informed decision.
1. Cost Segregation Is Only for Large Commercial Properties
A common myth is that cost segregation applies only to large commercial properties or high-value real estate. In reality, cost segregation can be beneficial for properties of all sizes, including residential rental properties and even smaller commercial buildings.
All properties have the potential for accelerated depreciation through itemized reclassification of components. For example, a small office building or a multi-family property can still benefit from cost segregation if a significant portion of the building’s components (like HVAC systems, flooring, and lighting) can be depreciated over shorter periods (5, 7, or 15 years). The best way to find out your potential tax savings is to reach out to us to create a free personalized Benefit Estimate.
2. Cost Segregation Is Too Expensive to Be Worthwhile
Many property owners believe that the price of a cost segregation study is too high, especially when they own smaller properties. However, the tax benefits of cost segregation often far outweigh the upfront cost of the study.
The price of a cost segregation study can vary depending on the complexity and size of the property, but the returns are typically significant. A well-executed study could yield tens of thousands of dollars in tax savings, particularly in the first few years when accelerated depreciation deductions are most impactful. Moreover, taxpayers can deduct the cost of the study as a business expense, which further reduces the financial burden. For lower basis properties, we offer an Acenalite service that reduces the cost while still delivering meaningful tax benefits without requiring a property site visit.
3. Cost Segregation Only Works for New Properties
There’s a misconception that cost segregation is only effective for new buildings or newly constructed properties. In reality, cost segregation can also be applied to existing properties. Whether you just bought it, have owned it for some time, or recently renovated it, these are all great reasons to look into conducting a cost segregation study.
If you own a property purchased or built several years ago, you can still perform a cost segregation analysis. Additionally, the study can “catch up” on missed depreciation deductions from prior years, which means you could potentially claim significant tax refunds through catch-up depreciation. This is especially valuable for the renovations that were mentioned earlier. These updates may have increased your potential depreciation deductions as well as the value of your property.
4. Cost Segregation Is Only About Accelerating Depreciation
While accelerating depreciation is the primary benefit of cost segregation, it’s not the only advantage. It is important to note that cost segregation can also improve cash flow by reducing taxable income in the short term. This will free up capital to allow for reinvestment, meaning you’ll save more money early on in the investment.
Check out our blog last week where we talk about How a Cost Segregation Study can Impact your Overall Tax Strategy.
5. Cost Segregation Is Only for Real Estate Investors
Cost segregation is often associated with real estate investors, but it’s not limited to this group. Any business or individual that owns income-producing properties, including small business owners, manufacturers, and even franchise operators, can benefit from cost segregation.
For example, a restaurant owner who invests in real estate or builds a new facility could use cost segregation to break down the building’s costs into personal property, land improvements, and building components, enabling them to take advantage of accelerated depreciation. Similarly, a manufacturer who owns industrial property could benefit from cost segregation by accelerating depreciation on machinery, equipment, and specialized components within the building.
Conclusion
Whether you're a real estate investor, a business owner, or simply someone who owns a property, it's worth taking the time to understand how cost segregation could benefit you. If you're still unsure about how cost segregation might work for your property, don’t hesitate to reach out to us. We can help clarify the process and determine whether it's a good fit for your situation. Don't let misunderstandings keep you from taking advantage of this valuable tax strategy.
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Edited by Randy Eickhoff, CPA, Founder & Head Coach at Acena Consulting. Photo courtesy of Paul McCarthy on Flickr.
