Cost Segregation can turbo charge your commercial real estate investments financial results by accelerating the depreciation schedule.
Paul Caputo with Segregation Holding LLC provides an explanation of how it works and what the benefit is to commercial real estate investors.
Depreciation is an accounting tool that recognizes each year, a percentage of your building’s life expectancy is used up. This loss can be recognized for tax purposes as an expense against the income generated.
When you purchase a building, regardless of the age of the building, the depreciation clock starts. The standard building depreciation schedule is 27.5 years for residential and 39 years for commercial.
If you purchase a residential property, ie an apartment building, and the building is valued at $2,750,000 at acquisition, the straight line depreciation would be $100,000 each year. This amount will be deducted from your income to determine the taxable income.
A cost segregation study breaks the building into its component parts. Depending on the estimated life expectancy of each building part determines the ability to accelerate the depreciation.
How Does a Cost Segregation Work?
When a property owner hires a cost segregation firm to do a study, the firm takes an engineering assessment of building. This process itemizes each component used to construct the building.
Instead of using straight line depreciation the building components are assigned a new depreciation schedule of 5, 7 or 27.5 years. This significantly compresses the time to depreciate the building.
For instance, if 15 percent of the building, $412,500 of the $2,750,000, is now assigned to 5 yr depreciation schedule. The difference in allowable depreciation between straight line and the accelerated schedule for these items assigned to the 5 yr schedule is:
Straight line over 27.5 years: $30,000
Accelerated over 5 years: $82,500
Additionally, when you have a cost segregation study, you can also capture the unused life of a component if you have to replace it prior to its scheduled life expectancy. So, if you have to replace a roof 5 years after you buy the building, you can recapture the 22.5 years left on the cost segregation schedule in the year you replace the roof. The new roof is capitalized at the replacement cost with the new life expectancy updated on the schedule.
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