Cost segregation is something people don’t talk about often. Most people are aware of tax depreciation associated with investment properties. Also most people use the standard variations of a few basic depreciation methods. However there are some pros and cons for the a real estate owner to consider concerning cost segregation.
Cost segregation affects your tax burden by changing your depreciation allowances. Like the name implies the segregation is the compartmentalization of you real estate into smaller parts. Some items can be depreciated faster or slower and some can get full depreciation if replaced earlier than originally anticipated.
Although cost segregation was originally about separating costs( its been around for 25 years) it is now a broader term used for real estate tax depreciation analysis. There are a number of services that provide cost segregation.
You may be thinking that this sounds great. Less taxes, and the segregation analysis is deducted from my tax savings so it’s basically like they are paying you to do the study. I will not attempt to get into detail of schedules and amounts however from the property owners point of view there are a few things to consider.
1) Un-depreciated property which is being demolished ahead of schedule can be depreciated fully. It doesn’t take an analyst to figure that out. However you accountant or tax preparer may not include these things. An employee kitchen which was replaced after only ten years will have huge depreciation value left that will offset the cost of new construction.
2) Cost segregation studies aren’t free money. If you sell a fully depreciated asset then you will be subject to capital gains as an assessment on a property you depreciated to worthlessness. Meanwhile the cost segregation company walked off with a nice check many years ago and you are left to pay the bill.
3) You can recoup property that wasn’t properly depreciated before you were the owner. That means you can go back in time and bring that lost depreciation into the present.
4) By changing your depreciation you can affect your tax bracket now and at the time you sell the real estate. This could help in a variety of ways over the years depending on your situation. Or by simply collecting depreciation early you can invest that money instead of leaving it tied up in future deprecation expense.
I think it’s clear to anyone that as tax laws increase in complexity and tax burdens increase its best to extract cash early and invest wisely. Because its impossible to say what tax laws will be doing in 39 years there is a large burden of risk by building a tax plan in which there is some perceived payoff far into the future. With the current rate of inflation at roughly 9% you could very easily turn early depreciation into an inflation hedge. So while your real estate is appreciating so will your early depreciation simultaneously.