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Cost Segregation Explained

Partners' Network Blog

Cost segregation is a method that creates revenue in the form of reducing current taxes for real estate owners and developers.  The process allocates the entire costs of a building or other property into components that cause an acceleration of tax deductions with a resulting deferral of federal and state taxes.  While the study’s purpose is to reduce current taxes they are usually prepared by engineers.

Cost seg applies to companies and individuals who have constructed, purchased, expanded or remodeled real estate and can also be used in like-kind exchanges and step-up in basis transactions.

The ideal time to conduct the study is when a property is first placed in service, however it can be done anytime afterwards.  If not done initially it will require a change in accounting method in accordance with IRS procedures and it will reallocate misclassified assets without having to amend prior tax returns.

An example is where certain property in a building are reclassified as 5-year, 7-year or 15-year property also eligible for bonus depreciation rather than as 27.5-year or 39-year property.  This way substantial deductions are front loaded conserving cash that would otherwise have gone to the government.  Any size property can generally benefit from a cost seg study with no minimum and certainly no maximum property value.

Note that this does not result in reduced tax, but in greater deductions in earlier years freeing up cash that would have been paid in taxes.  Further, the results and changes apply only to tax reporting and have no effect on financial statements prepared on a GAAP basis.

Cost segregation studies have been around quite a while but with the growing complexity of the tax laws they have become much more common.  Withum has a group dedicated to performing these studies and you are welcome to contact John Hage, an engineer working out of my East Brunswick office, or Martin Harski in our Princeton office for additional details and if you want, a complimentary feasibility analysis and price estimate.  John’s email is jhage@withum.com and Martin’s is mharski@withum.com or you can contact me at emendlowitz@withum.com.  We also have a large real estate taxation group, so do not hesitate to contact us with any of your questions or concerns in that area.

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