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2023 Cost Segregation




Overview Property owners have the opportunity to utilize cost segregation to pinpoint components of their property that are eligible for accelerated depreciation. This strategy can aid in diminishing tax liability and augmenting cash flow in the preliminary stages of real estate ownership. It is frequently termed as cost segregation study and the accelerated depreciation method.


Do I Qualify for the Cost Segregation? If you have acquired real estate recently, cost segregation can be employed to segregate components of the property that depreciate at a faster rate than the entirety of the building. This can provide a boost to your cash flow and minimize tax liability during the initial years of property ownership.


2023 Cost Segregation Details Both commercial and residential property owners who have made recent real estate acquisitions can use cost segregation to differentiate components of the property that experience quicker depreciation than the entire building. Depreciation denotes the reduction in an asset’s value as time progresses.


How does Real Property Depreciation function? Real property, which includes houses and commercial structures, isn't expensed in the year of its purchase. Rather, it's perceived as a long-term asset and is depreciated over its functional life — 27.5 years for residential real property and 39 years for commercial real property. To illustrate, on a $1 million commercial property, you'd be entitled to a yearly depreciation of $25,641 ($1 million divided by 39 years).

Cost segregation can potentially enable you to avail the benefit of immediate expenses on real property.


How is Cost Segregation implemented? Upon purchasing real property, you typically acquire the entire asset, encompassing the building and the land. While land cannot be depreciated, a cost segregation study can be executed to identify different asset classes within the building.


A cost segregation study can be conducted using software or by consulting a specialized firm. The study categorizes personal property items within a building, such as carpeting, lighting fixtures, and kitchen appliances, into shorter class lives (5, 7, and 15 years). These shorter asset life classes can adopt accelerated depreciation, leading to elevated depreciation expenses initially and reduced expenses subsequently. Certain assets might also be eligible for bonus depreciation or Section 179 expensing.


While the cost segregation study doesn't amplify the cumulative depreciation on the building, it accelerates depreciation in the ownership's initial years. This implies that depreciation in subsequent years will be diminished. When juxtaposed with straight-line depreciation over 27.5 or 39 years, a cost segregation study can yield substantial tax savings during the early years of building ownership.


It's recommended that properties valued above $500K undergo a cost segregation study by a firm specializing in these studies.


Benefits

  • Enhanced deductions in the early years to mitigate taxable income.

  • Potential for bonus depreciation or Section 179 expensing of properties that might not ordinarily be eligible.

Considerations

  • Diminished depreciation deductions in subsequent years.

  • Cost segregation study expenses (either software or consultancy).

  • Elevated risk of audit.

Assumptions When Opting for Cost Segregation You've owned the building for a brief span, making you eligible for added depreciation.


Requirements for Cost Segregation

  • A rightful ownership in real property is mandatory.

  • Execution of a cost segregation study.

  • Expert evaluation is advised for properties appraised at over $500K.

Business Entities Eligible for Cost Segregation

  • Schedule C

  • Schedule E

  • Schedule F

  • Farm Rental

  • S Corporation

  • C Corporation

  • Partnership

Conclusion: Cost segregation is a strategic tax planning tool that allows property owners to maximise their immediate tax deductions by identifying and separating specific components of their real estate that can be depreciated over a shorter lifespan. While it requires an initial investment in the form of a study (typically for properties valued over $500K), the resulting acceleration in depreciation can lead to significant tax savings in the early years of property ownership. However, it's essential to note that while this method can boost cash flow in the initial years, it may reduce depreciation deductions in the latter years. Engaging with experts and understanding the implications of a cost segregation study can help property owners make informed decisions about their real estate investments.

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