Engineering-based cost segregation is the process of reallocating real property (Section 1250) to property components considered personal property or land improvements (Section 1245) under the federal tax code. A cost-segregation study reclassifies these assets to shorter depreciable lives for tax purposes, thus reducing current income tax obligations. Engaging a cost-segregation expert to perform an engineering- based analysis enables building owners to depreciate their building (new or existing) in the shortest time permissible under current tax laws.
Building owners can also recapture “missed” depreciation for past construction, purchases, expansions, renovations and improvements. In these cases, no amended tax returns are required. The so-called “catch-up” depreciation is taken in one year by filing Form 3115 (Change in Accounting Method).
In general, buildings can be depreciated over either a 27.5-year or a 39-year period, but certain categories of fixed assets within a building can be depreciated more quickly, over 5, 7, or 15 years, resulting in significant tax savings. It is important to enlist the services of your CPA and their cost-segregation specialists to identify and reclassify these assets. This reclassification of the building’s components results in increased cash flow and reduced tax liability.
$9,544,084 garden style apartment complex, placed in service in 2012 with tax filing in 2012.
5 Year Property – $1,916,745
15 Year Property – $833,034
(Based on a 40% Tax Rate and a 5% Discount Rate)
Projected 1st Year Tax Savings – $151,510
Projected 5 Year Tax Savings – $634,762
By partnering with The Jennings Denovich Group, this CPA helped their client increase their depreciation, reduce their tax liability, and increase cash flow of approximately $634,000 in the first 5 years of ownership.
Each $100,000 in assets reclassified from a 27.5-year recovery period to a 5-year recovery period results in approximately $13,000 in net-present-value savings, assuming a 5% discount rate and a 35% marginal tax rate.
Source: Journal of Accountancy – August 2004