The Cost Segregation Study Process for Achieving Real Estate Investment Tax BenefitsIf you are among the millions of people taking advantage of real estate investing, then you may have overlooked one of the most simple and practical ways to take advantage of your ownership. Real estate investors and owners can greatly benefit from using cost segregation studies in order to accelerate the overall property depreciation. This may sound baffling at first glance, but when you realize the dramatic current income tax benefit, the advantages become much clearer.
You can use this tax benefit if you have an investment property in one of the following categories:
Generally speaking, the tax benefits increase with the specialization and cost of the property. Unfortunately, these benefits are neither utilized nor maximized by real estate owners as all too many of them fail to have a cost segregation study performed on their investment.
What is this magical, advantageous cost segregation study, you ask? Good question. A cost segregation study (sometimes referred to as CSS) is an analysis performed on a property in order to determine the total cost or value of a building on a property, as well as any site improvements that have been made. These studies rarely include either an analysis of any actual land value, or the contents of the building, such as fixtures, furniture, and equipment.
A CSS looks into the allotment of value or cost among each of the different elements of the building itself as well as the site improvements, in a way that recognizes certain federal tax depreciable life categories. In order to reach an optimal level for the reclassification from a longer to a shorter lifespan, a detailed CSS analysis of a property is necessary. This CSS is performed by qualified engineers and appraisers and accountants.
Only by understanding certain tax guidelines and regulations, as well as tax court cases, revenue rulings, and other current and relevant legislation issues, is an appraiser capable of accurately performing a cost segregation study.
If you are a taxpayer who has acquired a property, constructed a building, expanded on a facility, or otherwise changed the tax basis of their real estate ownership or investment property, then you qualify for using a CSS and enjoy the benefits it can offer you. You may also perform a CSS if you have a property that has been constructed or acquired in the past ten years, if it had not been performed at the initial time that the property was placed in service.
Typically, the methodology of CSS requires that the person (or people) performing the study must develop a completed and detailed comprehension regarding the entire cost or value of the real estate investment so that it may be analyzed at the level of total depreciation for taxes. In order to accomplish this, a detailed accounting of the cost of the land itself, as well as any site improvements, structures, and equipment in use on the property must be provided. In the case of a new construction, additional details are required regarding the direct and indirect costs. What is the difference between these costs?
Direct costs are those paid for labor and materials in order for the structure to be built. Indirect costs, on the other hand, are those paid so that the project may occur, but that are not directly relevant to the actual labor and materials going into the construction. Indirect costs will usually be allocated to direct costs on a pro rata basis.
The next step is the inspection of your property in order to completely understand the function, nature, and operation of each of its elements. At this time, the appraiser will also confirm the accuracy of any documents that have been created or submitted about the property. This is an essential step in the process as it allows for the identification of the exact property classifications associated with the depreciable federal tax lives. The property units are established by asset function.
The most involved and important stage of the CSS is the precise identification and quantification of the asset components qualifying for 5-year, 7-year, or 15-year depreciable tax lives. Frequently, in the case of a recently constructed property, detailed information regarding the construction costs can provide a breakdown of the different costs incurred. The CSS will analyze and supplement this information with "quantity take-off estimates" which allow for the further reclassification of more of the property into a shorter tax life.
Lastly, the analyst must then document and report what has been found throughout the rest of the CSS process. This usually means that the process of identification and quantification will need to be supported with additional documentation and calculations. Generally, these will be referenced using an automated computer- based report specifically for cost segregations.
The report that is produced allows for the full description of the property, as well as the different efforts made in order to conclude on the quantification and the property life, as well as the supporting data. All of the procedures of analysis requiring continual, logical, and supportable reporting are provided. Other related and supporting calculations from different portions of the process will also be included in the report.
Finally, a cost segregation study, when conducted well, will always include a detailed, referenced work-paper file. Its purpose is the support all of the final conclusions that have been made by the CSS. This also allows for an audit trail. Should additional, similar property portfolios exist, a sampling methodology may be utilized in order to support the analysis that has been made.
By having a cost segregation study done at the right times throughout the ownership of your real estate investment, you can take advantage of a substantial tax advantage that is well worth your while.