The Basics

A cost segregation study, commonly known as ‘cost seg,’ is a powerful strategic tool for residential and commercial property owners. A cost segregation study is a formal analysis that categorizes the various components of real property into different asset classes for depreciation purposes. Cost segregation studies are performed by a team of engineering and tax professionals with specialized experience in the field. The study includes an examination of various cost and property records, along with physical site inspections, to gather the necessary data to categorize the property components.

For income tax purposes residential property is typically depreciated over a 27.5-year useful life and commercial property is typically depreciated over a 39-year useful life. The acquisition cost of residential and commercial property is generally depreciated using a straight-line method and not eligible for accelerated bonus depreciation. However, certain components of a property, such as land improvements, plumbing equipment, fixtures, lighting components, and more, have a shorter useful life for income tax purposes and can be eligible for accelerated bonus depreciation.  A cost segregation study is used to breakdown the building asset and identify those various components in order to accelerate the timing of the depreciation expense for the property owner.

Look-Back Study

Cost segregation studies are typically conducted shortly after the acquisition of the property. However, properties that have already been placed into service still have an opportunity to pursue the benefits of a cost segregation study through what is known as a ‘look-back’ study.

In a look-back cost segregation study the depreciation deductions are caught up to what they would have been had a study been conducted in year one. More specifically, you look at the actual cumulative depreciation deductions taken since the acquisition of the property vs. what the depreciation deductions since acquisition would have been had a cost segregation study been completed in year one. These catch-up deductions are then taken in the current tax year without the need to amend a prior period tax return.

There are many instances where deductions from a cost segregation study would be worth more in one year versus another.  The timing and strategy of a cost segregation study is something that property owners and their tax advisors should discuss.

Look-Forward Planning

In the coming years there are certain elements of the tax law, directly related to the benefits of cost segregation studies, which are scheduled to change (as the law stands today). A few specific highlights:

• Bonus Depreciation Outlook – for tax year 2024, bonus depreciation is set at 60% of acquisition cost for eligible assets, and that is set to decrease to 40% in 2025, 20% in 2026, and phaseout completely by 2027.
• Section 199A Outlook – the 20% qualified business income deduction, commonly known as ‘QBI’, is scheduled to sunset in tax year 2025. Absent a change in the tax law, tax year 2026 will be the first tax year without this deduction that most have come accustomed to over the recent years. As a result, a tax deduction in 2026 could be worth more than a tax deduction in 2024 or 2025.

What does this mean for cost segregation studies and the timing of their implementation? Timing is critical – with the changing landscape of the Section 199A and bonus depreciation deductions, along with other areas of the tax law, it will make cost segregation decisions more involved. An experienced tax professional can guide you through the process and analyze the most beneficial strategy for your property.

Conclusion

Like most things there is a cost benefit analysis to consider and choosing to do a cost segregation study might not be appropriate in every situation. It is important to understand the mechanics and potential benefits that a cost segregation study can provide to property owners and investors, specifically over the next couple of years with the scheduled changes to the tax law on the horizon.

If you are considering a cost segregation study for your property our team at Snyder Cohn is here to assist you navigate this area and plan for the future!

 

By: Dustin Cutlip