What is Cost Segregation?
Cost Segregation is a tax planning strategy that is widely accepted (even recommended by the IRS) and highly beneficial for commercial real estate owners and tenants to accelerate depreciation deductions, defer and mitigate tax and improve cash flow. The practice of engineering based cost segregation studies has become routine for commercial property owners of almost every size.
A cost segregation study (CSS) is based on a detailed engineering analysis which is used to support accelerated depreciation deductions by identifying costs that can be allocated to shorter recovery periods (5,7 or 15 years) compared to the standard 27.5 years for residential rentals and 39 years for commercial property. A quality study provides the documentation required by the IRS to defer substantial tax payments and generate immense cash flow. Cost segregation studies do not create new tax deductions, they increase deductions in the early years of property ownership. This strategy of front loading depreciation allows the taxpayer to take advantage of the time value of money.
What is being said about Cost Segregation?
 "It is not unusual for engineering consultants to classify 20-40% of
construction as personal property"
Benefits of Cost Segregation
There are many benefits associated with cost segregation. The primary benefit is obvious- significant improvement in cash flow. This is achieved by the acceleration of depreciation deductions and the resulting tax deferral. In addition, cost segregation studies may also allow a property owner the following benefits....
- Reductions in estimated quarterly tax payments
- Savings on property tax
- Transfer tax savings
- A reduction in insurance premiums
- and more
   
What Properties Qualify?
- New Construction
- Existing Properties
- Acquisitions
- Redevelopment
- Leasehold Improvements
- And others
Any type of commercial property or residential rental property (No matter the size) placed into services after December 31, 1986 would qualify for a cost segregation study. Typically, cost segregation studies make the most sense for properties with a depreciable cost basis of $1 million or more- but there are exceptions. When looking at tenant improvment situations, the cost basis/value range drops to $250,000.
The History of Cost Segregation
Cost Segregation as we know it today is an off shoot of component depreciation which began in 1959. In 1986, the Tax Reform Act disallowed the use of component depreciation. Following the Tax Reform Act of 1986, there have been numerous court cases that ruled in favor of cost segregation as a legitimate tax strategy. The most famous court case was the 1997 Hospital Corporation of America case (HCA v. Commissioner) in which the court ruled that the definition of personal property, as previously defined by the courts during the investment tax credit (ITC) era, were still good. This case served as the landmark decision for cost segregatio, providing the legal support to use cost segregation studies as a way to compute depreciation.
The IRS released the first version of the Cost Segregation Audit Techniques Guide (ATG) in April of 2004. The purpose of this document was to provide IRS examiners with a more in-depth understanding of cost segregation studies. The ATG lays out the ground rules and legal framework for cost segregation including what elements are needed for a quality report, what qualifies as a proper study and industry specific guidelines.
The ATG also makes reference to the qualifications of a cost segregation study provider. The ATG states that studies done by engineers are more reliable that ones conducted by someone without an engineering or construction background.
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