Typically, when an investor purchases a commercial building, the IRS allows the cost of the building to be written off over a period of 39 years. That’s a very long time to recover your cost and that’s just for the portion of the cost allocated to the building itself, not the land it sits on.
Since land doesn’t depreciate and lose its useful life, the IRS doesn’t allow for this portion of the purchase price to be depreciated for tax purposes. For example, if you purchase a building for $750,000 and the land is valued at $112,000, that leaves $638,000 left to depreciate over the next 39 years. That equates to an annual tax deduction of just over $16,000 per year.
Cost segregation studies are used to determine the allocation or reallocation of the total cost of the property into different property classes and recovery periods. This is important in order to properly compute depreciation deductions.
In other words, it takes different components of your building and identifies them so they may be deducted under a different asset class with shorter recovery periods. This equates to a larger depreciation deduction and opens the door for other, more aggressive depreciation methods such as bonus, MACRS or possibly section 179. If you’re new to the concept of depreciation, be sure to check out my video on depreciation methods to learn more.
Cost segregation studies are performed for both newly constructed property as well as the purchase of existing property and for several reasons beyond just income tax purposes. They are also beneficial for more accurate financial accounting, as well as for insurance and property tax purposes.
The results of a cost segregation study is typically summarized in a report and, although there really isn’t a standard report format that exists, it should be prepared by a qualified professional.
If you have a tax or accounting question, visit my website to find more educational resources.
Read Want To Write Off Your Commercial Building or Rental Property Faster? What You Need To Know About The Cost Segregation Analysis! and the other informative articles in this issue of Soar to Success magazine.