This method enhances short-term cash flow by deferring the tax liability for increased depreciation on qualified assets. Lower tax liability, higher probability, and enhanced cash flow are the three important factors that make cost segregation essential.
The lower taxes and increased cash flow indicate that the plans for the business can be crystal clear and implemented more easily. This is why engineering cost segregation is always the main part of success for real estate developers and investors. In this specific blog, you will learn more about cost segregation.
Who Can Use a Cost Segregation Study?
One of the simplest ways to decide your eligibility for cost segregation is to see if your answer is ‘yes’ to any of the following questions:
- Did you recently purchase a new building?
- Did you recently build, or are you planning to build a new apartment?
- Have you expanded or remodeled a current building recently?
Cost Segregation in Practice
Renovating, remodeling, constructing, and getting real estate for commercial use usually results in the depreciation of those assets over a 27 to 39-year period. The timescale is dependent on quite a few factors such as if they are residential (single-family homes, apartment blocks, and much more) or commercial (warehouses, gyms, shopping malls).
Identifying the particular and IRS-approved parts that can be segregated from the rest of the real estate can easily be allocated to the depreciation categories. The three main categories are specific additions to the main structure of the building, land improvements, and personal property.
These components might be written off in five, seven, or fifteen years. It is also possible to reduce the income tax liability by around $70,000 for every $1,000,000 of building cost per basis owned. The specific savings are usually based on detailed cost segregation evaluation applying the IRS-approved standards.
What is the Use of Cost Segregation in a Business?
Some of the uses of engineering cost segregation in a business are as follows:
- Simple depreciation acceleration
When any new apartment or a piece of real estate is constructed, there is some period before the value will increase enough for it to be sold at a profit. To maintain the property, there will be costs, and those costs can be less than the corresponding income. The property and income taxes also become payable. The amount of tax that becomes due is reduced by around 27.5- or 39-year depreciation write-off approach.
Cost segregation can help reduce tax liability, and by shifting the depreciation of approved components from 27.5 or 39 to 5,7, or 15 years, the accelerated depreciation lessens every year’s tax liability. By reducing the cash for running costs, tax payments and capital for further investment are automatically generated. It also does not need to be borrowed.
- Partial asset disposition
If your property is being renovated, then some parts will be removed and replaced with new and improved parts. The old and new parts will also be depreciated, and unless (PAD) or partial asset disposition is taken, double depreciation of the old and new assets will keep accumulating. This can also impact tax calculated at the ultimate sale, and the recapture tax will be reduced by having previously segregated parts into different asset classes.
- When there is more availability, there is a greater benefit
Cost segregation was once used mainly by big corporations, but today, the properties with a cost basis in hundreds and thousands compared to the tens of millions of dollars qualify for accelerated depreciation. This is why the principle is both important and viable for the small developer or investor.
- Time value of money
One of the simple benefits of applying an engineering cost segregation strategy is that the money that is available today will be worth more than the ultimate profit made available at the ultimate disposition. The cash flow improves with the acceleration of depreciation, even by a small amount on lower-value properties.
After this cash becomes available for both growth and running costs and when used for investing in extra properties, components in the new properties will also be subjected to accelerated depreciation, increasing the benefit.
- Cost segregation and 1031
Acquiring real estate benefits from tax deferrals of capital gains when it is managed from a 1031 Exchange. The enhanced profit generated by segregating costs is not, and it is not necessary to be subjected to immediate taxation payable on sale. It is said that all taxes can be deferred.
Corporate and personal investors can use the Tax and Jobs Act legislation and avoid paying the tax when they move out of active property ownership. They also reinvest in approved development zones, and the deferred tax will be forgiven after some time.
As you can see, engineering cost segregation is important, and it helps increase the profit of a business and cash flow by accelerating the depreciation of real estate components. The immediate and long-term benefits make it an important strategy for real estate investors and developers. You can contact Lindon Engineering Services to perform cost segregation studies as they have a lot of experience in doing it and have performed these studies on different businesses.