The Benefits of Cost-Segregation Studies
When a commercial property is purchased or constructed, a
building asset is created and the dollars are entered into a fixed-asset system
as 39- or 27.5-year property. Using the straight-line method, owners can take portions
of the purchase as taxable income deductions each year of the schedule. Cost-segregation
studies, which analyze the components that make up the building and assign these
various components with recovery periods, can provide property owners with
distinct tax advantages over the straight-line depreciation method.
Cost segregation is a process in which detailed entries are
made in a fixed-asset system for all long- and short-life property. For
instance, certain aspects of the property may be assigned a three-, five-,
seven-, or 15-year tax life. These shorter lives are depreciated at an
accelerated rate that dramatically increases taxpayers’ federal tax deductions.
The impact of cost-segregation studies can be significant.
Property Analysis Example
The best way to illustrate the effects of cost segregation
is to compare a property with and without a study. For example, a taxpayer
purchases a strip mall for $1.3 million, excluding land and personal property.
If no cost-segregation study is performed, the taxpayer enters the cost into the
fixed-asset system as 39-year property. After the first five years, the
taxpayer has accumulated $154,622 in depreciation expenses. However, consider
the same property using cost segregation. After thorough engineering analysis
combined with an understanding of what qualifies as short-life property as
defined by Internal Revenue Code Section 1245, the strip mall is reclassified
into five-year ($260,524), 15-year ($348,590), and 39-year ($718,457) property.
After the first five years, the taxpayer has a total of $460,545 in accumulated
The obvious difference is that the taxpayer has increased the
accumulated depreciation expense by $305,000. With a cost-segregation study,
the taxpayer has taken the majority of his depreciation up front and realizes
that a dollar saved in the first five years is worth more than the same dollar in
16 years. As a result, the taxpayer has a net present value savings of almost
The distinction between what qualifies as short- and
long-life property has been shaped and reshaped during the last 20 years by
court cases, private letter rulings, and Internal Revenue Service publications.
With these ongoing changes, commercial property owners clearly can benefit from
a properly documented cost-segregation study.