Thousands of commercial property owners are overpaying income taxes because they are missing out on allowable depreciation expense on real estate. Commercial buildings since 1987 are depreciated by IRS rules over the useful life of the building - 39.5 years (or 27.5 years for multi-family structures).
Owners of commercial real estate can use cost segregation for depreciating a building instead of lumping the entire building into one depreciation class life. Cost segregation is the detailed review of a building, breaking out and documenting various components to withstand an IRS or even county property tax audit.
You break out each element of the building into its proper category, such as roofs, windows, doors, and then determine the class life for each element. The IRS code has 5-, 7- and 15-year depreciation life. What is not obvious is what part of a building falls into each depreciation class.
If you are an owner of a building, you will need to look at several factors to determine the proper class life of building components. This process is more complex than just breaking out floor coverings or cabinetry into the proper class. A front door for a medical complex may be properly classified into 7- or 15-year life depending if it is automatic, hydraulic or simply hinged, where a front door for a Home Depot or Wal Mart is more likely a 5-year life, if it lasts that long.
A common error is when the owner obtains the breakout from the contractor, for example, plumbing - $300,000. But in plumbing, there may be different components with varied depreciation life – pipes, fixtures, water heaters, and water purification systems. The usage of the building affects the probable life. For example, a water heater will obviously not last 39 years but will last even a shorter time in commercial use such as a laundry, kitchen or medical facility.
Another common error is there is not enough study as to how much of a property is raw land. Land is not depreciable, but improvements are, such as driveways, concrete, sprinkler systems, landscaping and more.
Cost segregation makes sense even if you have owned the building for a number of years. You may be eligible to have the cost segregation done and apply the "catch-up" of changing to a new depreciation method in one year. This can mean the recapture of thousands of dollars. Each $1 million classified from 39.5-year property to 5-year property equals more than $200,000 in net present value savings. Not only will the property owner save in federal and state income taxes but in property taxes as well.
Items that can be classified with shorter life in a cost segregation study will result in breaking out value from the real estate into personal property. Personal property taxes in most communities reduce as the asset depreciates over time where property taxes for a building are ever increasing – year after year. Some property owners have chosen not to take advantage of accelerated depreciation methods because they are nervous about IRS scrutiny and rationalize the depreciation isn't going away because it can be deducted over the next 39 years. It simply comes down to the worth of a dollar today compared to getting this dollar in some 30-plus years
Buildings that apply for cost segregation are commercial buildings owned by companies or investors who may face income taxation. This means dealerships, medical facilities, office or retail buildings and even storage units are all candidates for cost segregation.
Cost segregation methods have been around for years but the cost and complexity of the studies were such that only very large businesses could afford to jump through the hoops necessary to make them available. Further the probable need of defending yourself from the IRS was costly enough you had to have a very large complex to make this work.
Now with improved techniques by firms offering cost segregation studies and the IRS resolving many applicable issues in rulings and procedures, a knowledgeable user has a solid road map to a successful study.
If you own commercial property you should take advantage of cost segregation to pay the least amount of tax possible and use this money to make your investment successful.
