Even if the Building is Several Years Old, It’s Not Too Late

If you bought or built a building for commercial use within the past five years and did not have a cost segregation study done at the time, it’s not too late. And with inflation rapidly driving up costs and eating into profits, a cost segregation study could lower your tax bill and provide an important boost to your cash flow.

Building owners in certain industries such as health care and manufacturing may realize even greater benefits from a cost segregation study because of the specialized modifications of facilities used in those industries.

While the benefits of a cost segregation study diminish as your building progresses farther into its depreciation period, there is no time limit on when a study can be performed. Depending on your circumstances and the type of use, it could still be worthwhile to consider a study for a building you have owned for several years.

Accelerated Depreciation

In simple terms, a cost segregation study is a tax strategy that enables a building owner to front load deductions for certain types of property through accelerated depreciation, resulting in tax savings and improved cash flow. The process of a cost segregation study is to identify the building components that can be classified as personal property rather than real property, and therefore depreciated over a shorter period of time.

Certain improvements like removable flooring, parking lots, and plumbing and electrical upgrades installed specifically for equipment used in your business depreciate over a much shorter period than does the building itself. As the owner, you can recover the value of those items over five, seven, or 15 years, whereas the building depreciation stretches over 27.5 (residential) or 39 years (commercial).

Typically, cost segregation studies are done at the time a building is constructed, renovated or purchased. But not all building owners are aware of the advantages or make the time and investment to have a study performed at the original placed in service date. A few years down the road, when they’re looking for tax savings, a cost segregation study can be beneficial.

Specialized use of buildings in certain industries can make the case for a cost segregation study even more compelling.

For example, every building has electrical and plumbing systems. Most of those components are depreciated over 39 years along with the building structure itself. But depending on your business and the activity that takes place in the building, you may be able to allocate certain parts of those systems as depreciable over five years. If you have a double electrical load to run the equipment that are needed to manufacture your products, for instance, the depreciation of a portion of your electrical system can be shortened.

Likewise, in a manufacturing facility that is running forklifts and heavy machinery, there may be an opportunity to allocate a portion of the reinforced concrete floor as five-year property. Similarly, the owner of a medical building with 15 exam rooms, all of which have sinks and plumbing fixtures, would likely realize significant tax savings from a cost segregation study.

Change of Accounting Method

Performing a cost segregation study a few years into the ownership of a building requires a change of accounting method, accomplished by filing a Form 3115 Application for Change in Accounting Method with the IRS. This change is specific to depreciation and does not impact the way you keep your books.

If you would like to discuss a cost segregation study to improve your cash flow and push back on inflation, contact your Adams Brown advisor.