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Is the Benefit of Cost Segregation Worth It?

April 10, 2017

A simple case study.   [specialized tax incentives]

Cost segregation has the effect of increasing depreciation deductions which in turn reduces taxable income, and in turn minimizes taxes paid and maximizes cash flow. This article explores cost segregation by way of a simple example.

So, if a business or business owner in the 35% tax bracket can increase depreciation deductions by, say, $10,000, that has the effect of reducing taxable income by $10,000… the effect is that $3,500 less will go to the IRS (and $3,500 more would go to a business’ cash flow).

Cost segregation is a tax deferral strategy which 1) identifies, 2) separates and 3) classifies tangible real property assets into their shortest depreciable life (legally recognized recovery period) allowable.

It isn’t uncommon to have property with 5 to 7 years’ worth of usable life classified as 39-year straight line (S/L) depreciation items -- building components such as affixed cabinets, un-affixed floor coverings, and electrical components. Further, assets with 15 years’ of usable life are often miss-classified as 39-year S/L depreciation items, such as some parking lots, sidewalks, and storm drains.

What would be the tax implications of classifying an entire property as 39-year S/L versus taking the effort to segregate and reclassify property components into recovery periods between 5 and 15 years?

Let’s compare. Starting with the 39-year S/L depreciation on a $1MM building for example, we would be able to deduct $25,641 per year.
Suppose 15% of this $1MM (we exclude land cost) specialized office building (medical, laboratory, research, etc.) was classified as property with a five-year recovery period and 10% was classified as 15-year property. So, $150,000 of 5-year property would allow for $30,000 per year in depreciation deductions and the 15-year portion would create $6,670 in annual depreciation.

So, the annual difference between the depreciation deduction scenarios would be $36,670 – $25,641, or $11,000. This translates into paying $3,860 less in annual taxes over just the next five years, for a difference of paying $19,300 less in taxes.

This monetary difference after five years allows a business to have cash on hand to help replace those 5-year-life building components, especially if the cash difference was invested at a modest 4% annual return to help keep up with, or ahead of, inflation. Furthermore, in our government-sponsored inflationary environment, a dollar today is always worth more than one next year, let alone thirty-nine years hence.

Also, note: The benefits of cost segregation can be realized both retroactively and going forward even on properties purchased years ago.
We invite those interested in exploring the net benefit of an engineered cost segregation analysis to contact us. To assure you that we and you have the same incentive, your cost is limited to a percentage of the savings we find.

Call us to arrange a free (conservative) analysis of your tax benefits and so you can make an informed decision.