Commercial property owners may be able to reduce their near-term tax burden by accelerating depreciation on eligible building components. A cost segregation study identifies portions of a property’s depreciable basis that qualify for shorter recovery periods, allowing owners to claim deductions sooner.
Whether a property qualifies depends on its use, depreciable basis, placed-in-service date, and eligible components. The potential tax benefits must also justify the cost of a study.
Here’s what to know about cost segregation qualification, the properties that may benefit, and the information you’ll need to get started.
Cost segregation is a tax planning strategy that separates a building’s assets into categories with different depreciation recovery periods.
Under the Modified Accelerated Cost Recovery System (MACRS), nonresidential real property is generally depreciated over 39 years, while residential rental property is generally depreciated over 27.5 years. Certain building components, equipment, and land improvements may qualify for shorter recovery periods.
Accelerating depreciation can increase deductions in earlier years, although the actual tax benefit depends on the owner’s circumstances and the applicable tax rules.
There is no single property type or purchase price that automatically determines eligibility. Cost segregation is generally worth evaluating for depreciable business or income-producing property that contains assets eligible for shorter recovery periods.
Four factors help determine whether a property is a good candidate.
Cost segregation is commonly used by commercial property owners, real estate investors, and businesses that own their facilities. Eligible candidates may include properties held through corporations, partnerships, limited liability companies, or other ownership structures. The entity’s tax treatment affects how depreciation deductions are reported and used.
You do not need a traditional office building to qualify. Warehouses, manufacturing facilities, retail properties, hotels, and multifamily rental buildings may also warrant consideration.
A property’s depreciable basis is the amount of its cost that can be recovered through depreciation. For purchased property, this generally begins with the allocated purchase cost, excluding land, and is adjusted as required. Construction costs and qualifying capital improvements can also contribute to the basis.
Land itself is not depreciable. A higher depreciable basis may create more opportunities for tax savings, but the property’s value alone does not determine the potential benefit. The amount and classification of eligible components also matter.
Property generally becomes eligible for depreciation when it is ready and available for its intended business or income-producing use. This is known as the placed-in-service date.
The date may differ from the purchase date. For example, a building acquired in March may not be ready for use until renovations are complete later in the year.
The placed-in-service date affects depreciation calculations and the tax rules that apply. Keep records establishing when the property became available for use, particularly after an acquisition, construction project, or renovation.
A cost segregation study identifies assets that can legitimately be depreciated over shorter periods than the building itself.
Depending on the property’s design and use, these may include:
Not every asset in these categories automatically qualifies. Classification depends on the component’s function, construction, relationship to the building, and applicable tax rules. A qualified study documents the basis for its classifications.
Many types of commercial and investment real estate can benefit from a cost segregation review.
Examples include:
These are potential opportunities, not guaranteed classifications. Two properties of similar size and value can produce different results because their construction, equipment, and intended uses differ.
The documentation needed for a study depends on the property's age, size, construction history, and available records. The goal is to establish its depreciable costs and support the classification of individual assets.
Gather documents that establish the property's cost and depreciation history, including:
These records help the study preparer determine the property's basis and identify costs requiring further investigation.
Architectural drawings, engineering plans, construction specifications, equipment schedules, and site plans can help identify eligible components.
If original records are incomplete, the preparer may need to use other methods to establish asset costs and classifications, such as a site inspection or construction-cost estimates. Missing original plans do not automatically disqualify a property, but the study still needs a defensible basis for its conclusions.
A cost segregation study should explain how the property's costs were identified, allocated, and classified. Supporting calculations and records help demonstrate that the resulting depreciation deductions comply with applicable tax requirements.
The IRS Cost Segregation Audit Techniques Guide discusses the methods and documentation used to evaluate these studies. Although it is an examination guide rather than a universal prescribed study format, it provides useful context for understanding documentation expectations.
Work with professionals who understand tax depreciation, construction costs, and asset classification. Your tax advisor should also review how the findings affect your returns and overall tax strategy.
There is no universal IRS minimum purchase price for a cost segregation study. The practical question is whether the property has enough depreciable basis and eligible components to justify the study’s cost.
Consider these factors:
A smaller property may be worth evaluating if it has a favorable combination of depreciable basis and eligible assets. A higher-value property may offer less potential if few costs can be reclassified.
Not sure whether your property is a good candidate for cost segregation? Speak with an Acena expert to discuss your property and potential tax savings.
Yes. A property does not need to be newly acquired or recently constructed to warrant a cost segregation review.
Owners who have held a property for several years may still have an opportunity to review its depreciation treatment. A study can identify assets that may have been depreciated over a longer period than the applicable rules require.
Correcting depreciation on property placed in service in a prior year can involve additional tax procedures. Depending on the circumstances, the owner may need to request a change in accounting method, potentially using IRS Form 3115, rather than simply amending a prior return.
The appropriate approach depends on the property's depreciation history, previous filings, and current tax rules. Consult a qualified tax professional before changing how you report depreciation.
Cost segregation may help commercial property owners accelerate depreciation, but the potential benefit depends on the property’s depreciable basis, eligible components, placed-in-service date, and your tax circumstances.
Contact Acena to discuss your property and determine whether a cost segregation study makes sense for your situation.