Decreasing Tax Liability Through Cost Segregation
Learn how to make the most of your money and secure your future with a cost segregation study.
As tax day approaches, many business owners are contemplating ways to decrease their tax liability. Most companies already know about sheltering profits in retirement accounts or giving to charity to help cut down their tax bill, but not many have heard of a cost segregation study. This method of decreasing your tax liability is often over looked by business owners. For owners who own the real estate in which their business operates, a cost segregation study coupled with an energy efficiency study could significantly lower the tax consequences as well as make the property more eco-friendly. A cost segregation study aims to seek out parts of the property which can be depreciated on a quicker basis than the building itself and identifies areas of improvements that can help lower ones tax bill, increase cash flow, defer taxes, and even reclaim “missed” depreciation deductions from prior years.
A cost segregation study is an IRS approved analysis of commercial property that is often used as a tax planning tool. The engineering based study aims to increase cash flow, decrease in the businesses’ tax liability, and recommend changes to ensure that the property owner is conducting business in the most efficient and effective manner possible. Cost segregation specialists analyze property to identify and reclassify personal property assets that can be depreciated in a shorter amount of time than the building itself can be. The cost segregation and energy efficiency studies will also indicate simple changes that can be made in order to reduce utility bills such as turning off unneeded lights and TVs, switching to more energy efficient light bulbs, replacing installation, and installing solar panels.
The average commercial building is depreciated over 39 years, which initially encompasses all interior and exterior parts that could be potentially depreciated faster if identified through a cost segregation study. On average, 20-40% of the parts can be identified as personal property with shorter depreciable lives, reducing the owner’s tax bill. Electrical installations, plumbing, mechanical components, signage, interior safety doors, fire protection, canopies, and finishes are common items that are identified in cost segregation studies.
Here are some rough reclassification estimates for various types of structures:
- Apartments: 10%-20%
- Hotels: 20% – 30%
- Office Buildings: 10% – 20%
- Retail Stores: 15% – 25%,
- Grocery Stores: 20% – 30%
- Manufacturing: 20% – 60%
- Research and Development Facilities: 30% – 60%
- Restaurants: 25% – 35%
- Warehouses: 10% – 20%
Cost segregation studies are most beneficial when performed within a year of the purchase, remodel, or construction of the property, however the study can be done at any time. Cost segregations have been proven to be useful on buildings up to 40 years old. If the assets have not been properly depreciated, the business may be allowed to claim “missed” depreciation from prior years which results in further tax deductions.
Time value of money is an important concept to remember when considering whether or not to have a cost segregation done on a business. Time value of money is the principle that money today is worth more than money tomorrow, which also applies to tax deductions. By accelerating a building’s depreciation, property owners can lower their tax liability and thus realize a significant increase in cash flow. This larger cash flow, resulting from postponing tax payments, is available for other investments.
Although a cost segregation study can be performed on any building, there are some properties that have historically realized more profit than others. Below is a list of common properties that usually benefit greatly from a cost segregation study.
- Retail
- Grocery stores
- Office buildings
- Financial institutions
- Hotels
- Warehouses
- Manufacturing
- Processing plants
- Medical buildings
- Nursing homes
- Restaurants
- Apartments
- Sports complexes/ stadiums
Example:This is a high-level example for a build out with $500,000 cost.
**40.5% Tax Rate assumed
The cost segregation results in an immediate increase of the tax deductions yielding a cash benefit of $50,288 in the first year. This benefit is supplemented by the time value of money created by the acceleration of depreciation over time.
Buying a business is a major decision, so you’ll want to make sure you have a full scope of understanding of the business you are looking to invest in. There are limitless resources and tools out there to assist buyers in their journey to entrepreneurship and securing a successful future for their business. If you have recently purchased a business and would like to see what a cost segregation study could do for you, contact us today. If you are still in the exploratory stage of purchasing a business, we can help with that too. To learn more about having a cost segregation study conducted, we are able to refer to one of the best cost segregation specialists in the area and elaborate on how this information can support your entrepreneurial goals.