By Amar Patel I Principal, Cost Segregation
Commercial real estate owners can utilize cost segregation to accelerate depreciation and improve cash flow in the current tax year. Because commercial buildings are generally depreciated over 39 years for tax purposes, identifying components that qualify for shorter recovery periods can provide opportunities to accelerate deductions into earlier years through the use of bonus depreciation.
For qualifying commercial, residential rental, and mixed-use properties, CostSegregation.com makes the process more accessible. Built by KBKG, the leading cost segregation provider in the country, the platform utilizes property data and proprietary software to generate a full cost segregation report in under 15 minutes.
This guide explains how cost segregation works for commercial real estate, when it may be worth considering, and how property investors can estimate potential tax savings utilizing KBKG software solutions.
Key Takeaways
- Cost segregation can help commercial real estate owners accelerate depreciation and improve cash flow.
- Newly acquired, renovated, newly constructed, and prior-year properties may still qualify for cost segregation.
- Cost segregation software, like CostSegregation.com, gives property investors all the benefits of cost segregation with revolutionary speed, simplicity and cost-effectiveness.
What Is Cost Segregation for Commercial Real Estate?
Cost segregation is a tax planning strategy that reclassifies certain building components into shorter depreciation categories. Instead of depreciating an entire commercial building over 39 years, a cost segregation study separates qualifying assets into shorter recovery periods under MACRS.
By identifying these shorter-lived components, property investors will be able to claim additional bonus depreciation on qualified components, which can be as high as 100% in recent years.
Common commercial property classifications include:
| Asset Category | Examples | Recovery Period |
|---|---|---|
| Personal Property | Specialty electrical, specialty plumbing, certain flooring, fixtures, equipment, cabinetry, and decorative finishes | 5 or 7 years |
| Land Improvements | Parking lots, landscaping, fencing, sidewalks, exterior lighting, storm drainage, and other site improvements | 15 years |
| Building Structure | Walls, roof, foundation, structural HVAC, core plumbing, and standard electrical systems | 39 years |
Cost segregation does not create a new depreciation deductions. Instead, it changes the timing of depreciation deductions by identifying which assets may qualify for accelerated treatment into earlier tax years.
How Does Commercial Cost Segregation Work?
A cost segregation study reviews a commercial property’s components and assigns them to the appropriate depreciation categories. The goal is to segregate assets that may qualify for accelerated treatment from the buildings’ structural components.
A well-supported study generally follows a structured process:
- Property review and documentation gathering: Property records, cost details, appraisals, construction information, and other available documentation help establish the property’s depreciable basis.
- Component analysis: The study evaluates building systems, finishes, fixtures, site improvements, and other property details that may affect depreciation treatment.
- Cost allocation and asset classification: Costs are allocated to specific components and assigned to the appropriate recovery periods, such as 5-, 7-, 15-, or 39-year property.
- Report preparation: The final report organizes the asset classifications, cost allocations, and supporting details that property owners and tax preparers can use when applying depreciation deductions.
- Filing support and audit readiness: A quality cost segregation report should provide clear documentation to support the tax position if questions arise.
Cost segregation software, such as CostSegregation.com, helps streamline this entire process using a self-guided, 4-step process that produces a full cost segregation report in less than 15 minutes.
Who Benefits from Cost Segregation?
Cost segregation can apply to many commercial and income-producing property types, listed here. The strongest candidates are typically owners of properties with enough depreciable basis and component variety to make accelerated depreciation worthwhile.
When it comes to CostSegregation.com, the self-guided software supports qualifying properties with a depreciable tax basis under $1.5 million, excluding land basis.
For properties above that range or with unusual complexity, a more traditional study may be appropriate; such as KBKG’s engineering-based studies.
When Should You Conduct a Cost Segregation Study?
The most common times to complete a cost segregation study are:
- after acquiring a property
- after completing new construction
- after finishing a major renovation
- when reviewing a property placed in service in a prior year
However, a prior-year property may still qualify for a cost segregation study. In many cases, missed depreciation deductions that are generated through a cost segregation study can be claimed through Form 3115, Change in Accounting Method and a Section 481(a) adjustment without amending prior-year tax returns.
This is another benefit of CostSegregation.com, as the platform includes a 481(a) catch-up adjustment schedule when applicable.
Properly Conducting Cost Segregation for Commercial Real Estate
A quality cost segregation study should be detailed, supportable, and properly documented. The IRS Cost Segregation Audit Techniques Guide outlines how studies are reviewed and why methodology matters.
For property owners, the key is having a report that clearly supports asset classifications and cost allocations.
Self-guided reports, such as CostSegregation.com’s, are backed by KBKG’s certified cost segregation experts, and include audit support for added confidence.
Conclusion
Cost segregation can be a powerful tax strategy for commercial real estate owners, especially for properties with components that qualify for accelerated depreciation.
CostSegregation.com makes the opportunity easier to evaluate. Property investors can start with a property-specific estimate and move through an efficient, self-guided process. An added benefit is that users only pay to download the study, not to complete it.
Different properties provide different potential benefits. Estimate your property’s tax savings with CostSegregation.com’s free calculator!
Frequently Asked Questions
Is cost segregation worth it for commercial real estate?
In many cases, yes. Commercial buildings are generally depreciated over 39 years, so reclassifying eligible assets into shorter recovery periods can create meaningful early-year deductions. The best way to evaluate the opportunity is to estimate the potential benefit for your specific property.
Can I do a cost segregation study on a property I bought years ago?
Yes. A look-back cost segregation study may allow you to claim missed depreciation through Form 3115 and a Section 481(a) adjustment, generally without amending prior-year tax returns. This is another feature provided by CostSegregation.com.
What types of commercial properties qualify for cost segregation?
Common qualifying property types include office, retail, warehouse, restaurant, hotel/motel, self-storage, medical, industrial, mixed-use, and other income-producing properties. However, the actual benefit depends on the property’s depreciable basis and component mix.
