If you acquire nonresidential real property or residential rental property, you may have an opportunity to reduce the depreciable lives on these assets with cost segregation, which could not only lower your tax bill over time but also help increase your cash flow. 

Our business tax pros break down cost segregation in these FAQs to ensure you maximize its tax benefits. 

What is a cost segregation? 

Cost segregation allows taxpayers the opportunity to accelerate depreciation deductions for their residential rental property and/or commercial buildings. Typically, commercial building spaces are depreciated over 39 years, while residential rental properties are depreciated over 27.5 years. Under IRS cost segregation guidelines, a significant portion of building and/or land improvements costs can be depreciated over much shorter periods – usually five, seven or 15 years.

To determine your potential tax benefit, have a cost segregation study conducted. With a cost segregation study, specialized pros can evaluate each property element and identify costs for qualifying building components to accelerate depreciation expenses. 

What are qualifying costs? 

Qualifying costs generally include: 

Qualified improvement property placed into service can also be depreciated with a 15-year recovery period. The requirements for qualified improvement property placed in service after 2017 must meet both criteria: 

• The property must be an improvement to an interior portion of a building that is nonresidential real property.
• The improvement must be placed in service after the date the building was first placed in service by any taxpayer. 

When should a cost segregation study be conducted? 

Ideally, a cost segregation study is completed prior to beginning construction, however, there are additional applications for this strategy that apply to various stages of real estate ownership and development, including:

• New construction
• Soon-to-be constructed buildings
• Existing properties
• Acquisitions
• Renovated and/or remodeled buildings
• Redevelopment
• Leasehold improvement

A cost segregation study can be completed after a building is placed in service. If you’re in the process of buying a property, the sales price can be allocated between real and personal property in the sales contract.

How do I file for cost segregation? 

The change to the depreciation lives requires either an amended return or an accounting method change (if it is two or more years after the property is acquired or placed in service). To file a change in method of accounting, you’ll need to file Form 3115. IRS reporting includes the change of basis, depreciable lives and any adjustments for the impact of the depreciation acceleration from the date the assets are placed in service to the year of the method change.

Are there any additional tax benefits? 

Beyond accelerating depreciation deductions, a cost segregation may also help you capture additional tax savings, such as: 

• State and local property tax reduction. Cost segregation may result in the reduction of state and local real property taxes by reducing building costs allocable to real property. Plus, several states provide sales and use tax exemptions for tangible personal property used in a manufacturing process or for research and development. A cost segregation study will identify such qualifying personal property, but the tax savings will depend on whether the property is classified as real or personal property, based on applicable state laws.
• Energy efficient commercial building property tax incentives. Cost segregation studies may help identify prior and current expenditures related to heating and cooling systems, ventilation, hot water systems, interior lighting systems and the building envelope that qualify for energy tax incentives, such as the 45L credit, Section 179D deduction and more. 

Ready to get started? 

Navigating through a cost segregation study is no easy feat. It requires thorough examination of each property, and pros who understand the nuances of qualifying building components. Our team of cost segregation specialists are here to help guide you through this complex process to ensure you reap the benefits of improved cash flow and reduced taxes.