Outside the world of accounting, cost segregation is not a terribly well-known concept.
If someone were to poll a random assortment of 100 people in any major city the odds are slim that more than 15 would be familiar with the process of cost segregation. Inside the world of accounting, however, cost segregation is a much better-known process, and for good reason: depending on the circumstances, cost segregation studies have the potential to save many thousands of dollars. Not every accountant is going to be a specialist in this area, but because cost segregation can have such a tremendous impact on the financial condition of businesses it is important for all accountants to be equipped with a basic knowledge of this process.
Basic Overview
In its simplest terms, cost segregation is about sorting personal property assets from real property assets for the purposes of shortening the time of depreciation and reducing overall tax liability. When a building is constructed, remodeled or expanded, not all elements of the building need to be classified as “real property” for tax reporting. Some elements, as we will explore further, can be considered personal property, and when considered as such they will have much shorter useful lives and can therefore be depreciated over a shorter span of time. Certain land improvements may also be separated from the land itself and regarded as personal property in the same fashion. Normally, real property assets are depreciated over a period of either 27.5 or 39 years; personal property assets are depreciated over five, seven or 15 years.
Classifying portions of real property as personal property typically means that a building owner is able to take advantage of deductions earlier than normal. As we all know, in the world of business, time has incredible importance, and so having access to cash at an earlier point in time can literally alter the entire future of a business.
Because of its associated expenses, cost segregation is usually only financially advisable for buildings that have been purchased or redone for over $200,000. Cost segregation can be applied to any building that has been bought, constructed, expanded or remodeled since 1987. Significantly, it is possible to apply cost segregation “retroactively” to structures that are not newly finished. This allows owners to reap the benefits of “catch up” depreciation.
Property Categorization
In general, the nonstructural elements of a building are eligible for classification as personal property assets. Nonstructural elements are items that are affixed or attached to the building but are not an integral part of its operation or maintenance. Hence, nonstructural elements generally refer to items such as wall covering, carpets, lighting, certain portions of the electrical system, and others as well. Land improvements such as sidewalk refurbishment and landscaping are typically classed as personal property.
Though these items are consistently categorized as personal property assets, it is important to note that every cost segregation study is unique and results are not predictable with 100 percent certainty.
Initiating a Study
Cost segregation studies are performed by individuals who possess the following two things: an ability to read complex architectural and engineering blueprints and a mental command of the most essential laws that apply to cost segregation. The IRS applies a heightened level of scrutiny to cost segregation studies because such studies can translate into so many thousands of dollars in savings. For this reason, specialists are usually hired.
Even though not every accountant will know the most minute details of cost segregation, all accountants should be conversant with this concept so they can better serve their clients.
