Cost Segregation Explained
Cost Segregation Simplified
Cost Segregation is the IRS guide-lined method of re-classifying components and improvements of commercial and residential real estate resulting in reduced tax liability and increased cash flow. It is applicable to both owners and lessees.
A third party certified study identifies, values and separates 5, 7 and 15 year depreciable life personal property from 39 or 27.5 year, depreciable life real property (dependent on if it is commercial or residential real estate).The net result creates significant acceleration of available tax deductions.
IRS guidelines allow this technique to be applied to newly built and existing buildings, irrespective of age. However, the building must have been placed in service no earlier than 1987. Number of years owned by current owner, prior renovations and future renovation plans are just some of the considerations used to determine whether a cost segregation study makes economic sense.
The technique has been widely used since 1997 as a result of two landmark tax court cases in which both Walgreen’s and Hospital Corp of America prevailed against the IRS. Traditionally, Big 4 CPA firms engineering departments have used cost segregation with their large clients. HL Cost Seg now cost effectively delivers this service to the middle and smaller markets as well.
Properties may be owned in a variety of entities. Most common are LLC’s and S-Corps. If an owner of an LLC which holds the property leases it to an operating entity typically an S-Corp which they also own, losses and gains are all active, because for tax purposes these common owned entities may be grouped.
Active and Passive
If an individual owns a single vacation villa and rents it out, typically the losses are considered passive. However, passive losses from real estate may be an offset to passive gains from other types of investments. Also, if an owner is classified as a real estate professional, which is a legal definition for tax purposes, all gains and losses are considered active.
The certified Cost Segregation company completes a no-cost estimate (Order of Magnitude Study) that usually is within 15% of the results of a certified study. The client will always be presented with a fixed, flat fee bid prior to engagement (or get this for free through our HL Cost Seg trade deal). This fee is based on size and complexity of the project. Net Present Value analysis usually shows benefits to cost ratios ranging from 10:1 to 30:1, based upon asset value and type.