Cost segregation is an IRS-approved method of classifying components and improvements of your property from real property to personal property. This process allows the assets to be depreciated on a 5, 7, or 15-year schedule instead of the traditional 27.5- or 39-year life of real property. This front-loads the depreciation on your property, reduces your taxable income, and increases your cash flow now. Commercial buildings and homes are made of various components (flooring, cabinets, doors, framing,
parking lots, etc.) that do not last 27.5 or 39 years so you shouldn’t depreciate them as such. By itemizing or segregating all components of a property via cost segregation, we create a tax deferral. A dollar in taxes saved today is worth more than a dollar saved in 3 or 5 years. These savings can be invested in property improvements (to raise rents), purchasing more property, reinvesting in your business, investing elsewhere, or spending on yourself.

The Tax Cuts and Jobs Act of 2017 created bonus depreciation, also commonly referred to as accelerated depreciation. For any property placed into rental service between September 27, 2017 (the date bill was introduced) and January 1, 2023, 100% of the items placed in 5-, 7- and 15-year categories can be depreciated up front in year 1. If income is brought to zero, the remainder is carried forward. The parts classified as 27.5- or 39-year property are depreciated evenly over that time.

Land is not a depreciable asset. Before depreciating a property via straight-line depreciation or cost segregation, land must first be deducted from the value of the property. Land value often falls in the 10-25% range.

Unfortunately, no. The basis of the property is based on the purchase price plus any improvements and less land. We cannot depreciate a building based on hypothetical market value. There needs to be a transaction for the basis to be reset.

NO, but bonus depreciation is currently in what we call a sunset period. Any property placed into rental service in 2023 is only subject to an 80% bonus. This means 80% of the 5-, 7- and 15-year items can be depreciated in year 1, with the remaining 20% being spread out over the 5-, 7- or 15-year period.
Properties placed into rental service in 2024 are subject to a 60% bonus, in 2025 40% bonus; 2024 20% bonus, and 2025 0% bonus. This assumes NO changes in the tax law.

What matters is when the property was placed into rental service, NOT when the study is performed. Placed into rental service is when it’s publicly listed for rent, not the day a tenant starts their lease. List it for rent December 31 and the lease commences months later? It was placed into rental service December 31.

Yes. Your accountant is using straight-line depreciation where the full value of the property is being depreciated evenly over 27.5- or 39-years, depending on what asset class it is. We will first run an analysis and talk with your team (accountant, financial advisor, etc.) to see if it makes sense. If it does, we will perform the study and sign and complete IRS Form 3115, the Application for Change in Accounting Method to change from straight-line depreciation to cost segregation.

When a tax method change occurs, whether it is from cost segregation, the Tangible Property Regulations, or any other tax method changes, a 481a adjustment must be used. This is because a different method of accounting was used from one year to the next. For example, you started depreciating your property using straight-line depreciation and now have switched to cost segregation. The 481a adjustment is done to prevent any income or expenses from being duplicated or omitted in the current tax year. The adjustment can be positive (increase income resulting in taxes owed) or negative (decrease in income and resulting in a tax credit). While all tax situations are unique, switching to cost segregation from straight line will likely result in a negative adjustment.

This allows the IRS to reclaim depreciation expenses that the taxpayer claimed in previous years. Cost segregation classifies components of the building from real property (Section 1250 property) into personal property (Section 1245 property). When personal property is sold, gains are paid at ordinary income tax rates. The recapture rate for real property is lower than personal property.

Yes. One method is a 1031 exchange as this defers tax liability by rolling the proceeds from one investment sale into an investment purchase. The other method is how the tax professional allocates the sale’s price of the building between land and building. TPTM can assist with this. We can also work with your accountant to minimize recapture. For example, if the property has been held for 5-years, the 5-year property has been fully depreciated and there is not recapture on this property.

Maybe. Cost segregation can only be performed on the portion of purchased property.

Also referred to as Section 263(a) or the Repair Regulations, the TPRs provide rules regarding the treatment of expenditures for acquiring, sustaining, or improving tangible property, including expenditures on buildings. They are mandatory to follow but extremely tax-payer friendly. They determine what renovations and improvements can be expensed and what needs to be depreciated. Using a firm that specializes in them can assist owners in deciding how and when to renovate or repair buildings so the expenditures can be expensed.

They’re mandatory to follow whether you’re a small investor or a big syndicate firm. More often than not, compliance with the tax code hurts the bottom line. With the TPRs, compliance often HELPS the bottom line. We can also help guide you on renovations and improvements as you own the property to help you expense as much as possible vs. having to depreciate it.

Yes, this is called a Partial Asset Disposition (PAD), part of the TPRs. PADs allow you to write off the remaining depreciable value of everything removed during a renovation or improvement plus the removal cost. These can be extremely valuable because this is a write-off or expense, which never has recapture.

When you purchase a building, the depreciable basis resets and is based on the purchase price so the value of everything being removed during a renovation is brand new in the eyes of depreciable value because the basis just reset! It doesn’t matter how old that carpet and original bathrooms are.

A PAD must be done in the year of the renovation so once you file your tax return, the opportunity is lost. Unlike cost segregation which can be done years after a purchase, a PAD cannot. You’re not even allowed to go back and amend your return.

No longer true. When Cost Segregation first hit the marketplace, studies were only done for multi-million dollar buildings and owners with deep pockets. There was not a cost-effective way to perform a study and the cost reflected that. As technology has advanced and tax engineers are better trained, the engineering-based cost segregation study, which the IRS recognizes as the most thorough, has become very affordable.

False. Cost-effective studies are being done daily on buildings with a cost basis of $300,000 and on renovation projects as low as $100,000.

Many do not realize that 20% to 50% and sometimes more, depending on the asset class, can be redefined as a short-life asset (i.e. 5-, 7- or 15-year property). Combine this large percentage with the low-cost fee, potential savings through cost segregation, the TPRs, and PADs, as applicable, and a significant return on investment can be realized. Even when a CPA accelerates some depreciation, an engineering-based study will uncover significant amounts of hidden opportunities.

Not true. Cost Segregation can be applied in any tax year for qualifying buildings without amending prior year returns. IRS Form 3115, the Change of Accounting Method, is necessary when changing methods of depreciation. TPTM not only fills this form out but also signs off on it, unlike most firms. The benefit to a “look-back study” is pulling all of the accelerated depreciation forward into the current year as if this method had been applied since the first year of ownership.

Not true, here’s the truth. Cost Segregation tax engineers will cost analyze a building, its structure, its systems, and its costs. A study completed by an individual having construction technology and experience is considered by the IRS to be the most reliable and thorough type of study. Where receipts and invoices are helpful, the practice of delivering lump sum pricing in construction projects will require construction technology expertise to identify all the component items buried in these bids that qualify for short-term depreciation.

FALSE. It is all about the time value of money. A dollar today is worth more than a dollar tomorrow. An engineering-based Cost Segregation study helps building owners maximize this basic finance principal.

Engineering-based Cost Segregation studies have been upheld as appropriate, valid since 1997, and no riskier than any other legitimate deduction. The key is having a well-trained team of engineers performing the study. We back all of our work with audit protection. Be weary of firms that won’t stand by their work. There are non-engineering based studies at lower costs. Not using the best-trained tax-engineers will leave tax savings on the table.

This is False. For buildings placed in service in prior years, owners need to have IRS Form 3115 completed and make a 481(a) adjustment for the current tax year. We sign and complete IRS Form 3115 and will work with your accountant to ensure it is properly implemented into the tax return. The 481(a) adjustment allows owners to bring forward the total of all allowable deductions which were not taken without amending prior year returns. Excess deductions can be carried forward until used.

This is not true. IRC Section 469 provides three specific exceptions to the grouping activities restriction that covers a very high percentage of commercial property owners. These three ways are the most common ways that a taxpayer may be allowed to use the cost results without limitations of the amount of passive income.

FALSE. If a firm ever guarantees a certain amount of bonus depreciation, run away. Every engineering-based cost segregation firm that follows the IRS guidelines will get the same results. They are either going to “fudge” the numbers to get that guaranteed number and leave you ripe for an audit or they will over-promise and under-deliver but earned your business. Be weary of firms that don’t provide audit protection for their work. They are hiding something.