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ALERT: 100% Bonus Depreciation Ends December 31, 2022

Cost Segregation for Commercial Real Estate

Learn about cost segregation analysis, a tax strategy used by commercial property owners.

Cost segregation for commercial buildings is like adding a supercharger to a performance car, in terms of boosting already favorable income tax provisions for real estate investors. Real estate is a large part of the economy and has received favorable tax statutes since before the 1950s. Both the magnitude of the real estate industry and its plethora of lobbyists (commercial developers, construction trades, bankers, appraisers, Realtors®, etc) are material factors in providing excellent income tax protection for commercial real estate investors.

Some commercial real estate investors have initially been reticent due to the high payoff ratios of cost segregation for commercial real estate. Year-one pay back ratios are often 10:1 to 100:1. (In other words, a 1,000 to 10,000% return, not counting possible recapture.)

calculate depreciation real estate

Advantages and disadvantages of cost segregation

  • A. Massive depreciation in the early years leads to massive tax savings
  • B. Additional gain on sale, if a sale occurs prior to the property going into an estate
  • C. Additional gain is typically capital gain contrasted to using the additional depreciation to offset

The U.S. government promulgates income tax statutes for two purposes:

  1. To raise revenue and
  2. To impact social and economic behavior.

Congress could easily eliminate cost segregation but has no interest in doing so; it is too obscure and too favorable to wealthy taxpayers. Cost segregation and various forms date back to the 1950s. The term used to be component depreciation. (Some walls / components in the building we occupy today were built a little differently to take advantage of component depreciation.)

Don’t fret about benefiting from massive income tax savings using cost segregation and bonus depreciation. You are simply engaging in economic activity designated by the U.S. Congress as desirable. Think of it as doing your patriotic duty while preserving your family’s / business’ assets wealth!

Finally, there are some uninformed practitioners who believe cost segregation ONLY DEFERS income taxes. This simply is not true. After working with thousands of clients, we can assure you that most of the additional depreciation is recaptured as capital gains income. The extra depreciation likely offsets ordinary income, which has a much higher rate of taxation.

Preliminary Analysis For a Cost Segregation Study

Do yourself a favor and obtain a detailed preliminary analysis. There is no cost or obligations. Many clients receive income tax savings of hundreds of thousands or millions of dollars using cost segregation. There are a number of owners of commercial real estate who have paid little or no income taxes in 10+ years due to cost segregation supplementing the other generous tax benefits of commercial real estate.

Finally, the IRS realizes that cost segregation is a more accurate means to allocate the basis of the property to the correct recovery period (5-, 7-, 15-, 27.5 or 39 years for most real estate.) They welcome cost segregation reports prepared with appropriate methodology, credible results and relevant documentation. The IRS specifies that to correctly depreciate real estate, it is necessary to identify the property by proper recovery period (life / age of components of property).

The following is a direct quote from the IRS Audit Techniques Guide for cost segregation. It is clear that the IRS states, “to calculate depreciation for Federal income tax purposes, taxpayers must use the correct method and proper recovery period for each asset…”