If you own investment property, you might be missing out on thousands of dollars in tax savings without even knowing it. A cost segregation study is a smart, legal way to find those hidden savings. It speeds up depreciation on parts of your property, which means you pay less in taxes and keep more cash in your pocket.
Today, we’ll explain cost segregation studies in simple terms. Whether you’re a real estate investor, small business owner, or just curious, we’ll help you decide if this strategy is right for you.
What is a Cost Segregation Study?
A cost segregation study is a tax-saving strategy for property owners. Normally, when you buy a property, you deduct its value slowly over 27.5 years (for residential) or 39 years (for commercial). But with a cost segregation study, your property is broken down into smaller parts, like lighting, flooring, and appliances that can be depreciated much faster, in just 5, 7, or 15 years.
According to the Internal Revenue Service (IRS), a cost segregation study allows taxpayers to identify and reclassify personal property assets to shorten the depreciation time for taxation purposes, which can lead to significant tax benefits.
Why does this matter? Faster depreciation means you get bigger tax deductions now instead of waiting decades. It’s like uncovering hidden cash in your property that helps lower your tax bill today.
How Does a Cost Segregation Study Work?
A cost segregation study helps you find hidden deductions by accelerating the depreciation of certain parts of your property. More deductions mean paying less tax, and keeping more cash in your pocket right now, rather than waiting decades.
Let’s break down how this process works in simple steps:
1. Spot the Quick-Win Items
The first thing that happens is a cost segregation expert (usually an engineer with knowledge of tax laws) takes a close look at your property. Instead of just focusing on the building as a whole, they zoom in on specific elements that can be depreciated faster, such as:
- Light fixtures
- HVAC systems
- Flooring and carpets
- Landscaping, sidewalks, and driveways
Why does this matter? Normally, these items would be depreciated over 27.5 or 39 years, depending on whether it’s residential or commercial. But here’s the catch: if you had bought these items separately (say, if they were part of a different project), the IRS would allow you to depreciate them in 5, 7, or 15 years. A cost segregation study reclassifies these components, speeding up the process and unlocking bigger tax savings sooner.
2. Gather the Paperwork
Next, the expert will need a few documents to help determine the value of your property and how to break it down into categories for accelerated depreciation. These documents might include things like blueprints or site plans, your original purchase agreement or closing documents, and any recent appraisals or inspection reports. Don’t worry, it’s not a mountain of paperwork—just the essential items needed to map out your property’s components.
3. Break It Down and Reclassify
Once they have all the necessary information, the team will start dividing your property into parts that qualify for quicker depreciation. They’ll categorize these items into sections that can be depreciated over shorter time frames—5, 7, or 15 years. This means you get the benefit of those deductions much sooner, which results in a significant reduction in your tax bill in the short term.
4. Get Your Tax Savings Report
Finally, after all the work is done, you’ll receive a detailed report that outlines exactly how much you can save. This report is then handed over to your tax preparer, who will use the breakdown to adjust your tax return. The end result? A lower taxable income and more money in your hands instead of the IRS.
By speeding up the depreciation of certain parts of your property, a cost segregation study lets you unlock tax savings that would have otherwise taken years to realize. It’s like finding hidden money in your property and keeping it where it belongs—with you.
Cost Segregation Study Examples
To help you understand just how much this can save, let’s look at a couple of real-world examples.
Example 1: John’s Commercial Property
John owns a commercial building worth $500,000. After getting a cost segregation study done, he found that $150,000 of his property could be written off faster. This helped him save $50,000 on his taxes in the first year. What did he do with that savings? He put it right back into his business to help it grow.
What does this mean for John? His tax savings didn’t just sit there; they worked for him, helping him invest in the next step of his business growth.
Example 2: Sarah’s Office Building
Sarah bought an office building for $750,000. After running a cost segregation study, she was able to reclassify parts of the property and save $70,000 on her taxes over just two years. That’s money she could use for things like expanding her team or making improvements to her business.
What does this mean for Sarah? The savings helped her business run more smoothly, giving her more flexibility to focus on growth.
Example 3: Mark’s Rental Property
Mark owns a rental property valued at $300,000. After completing a cost segregation study, he was able to accelerate depreciation on certain parts of the property, saving him $20,000 in the first year. With those savings, Mark was able to reinvest in new rental properties and increase his rental income stream.
What does this mean for Mark? The tax savings helped Mark scale his rental business more quickly. Instead of waiting years to see tax benefits, he was able to use that money right away to build more wealth through additional properties.
How Much Does a Cost Segregation Study Cost?
A professional cost segregation study usually costs between $5,000 and $15,000. The price depends on how big and complicated your property is. It might sound like a lot, but the tax savings you get could be way more than what you pay for the study.
Your Options:
- Professional Study
Cost: $5,000 – $15,000
This option is best for bigger properties or properties with a lot going on. Experts will come in, break down your property, and find all the ways you can save on taxes. It might be pricey, but for larger properties, the savings usually make it worth it. - DIY Study
Cost: $0 – $500
If you have a small property or you feel confident, you could try doing it yourself. There are tools online that can help. It’ll be cheaper, but there’s a risk. You might miss out on some tax savings, or make mistakes that could cost you later.
Is It Worth It?
Even though a professional study costs more upfront, you can often save much more in taxes, which makes it a good investment. For smaller properties, you might try doing it yourself, but be careful not to leave money on the table. Whatever route you choose, a good study can save you a lot more than you spend.
Can You Do Your Own Cost Segregation Study? (DIY Guide)
If you’re the hands-on type, you might wonder if you can do a cost segregation study on your own. The short answer? Yes, if the property is simple enough and you’re up for it. But it’s not a walk in the park, so let’s break it down step-by-step.
Step-by-Step DIY Guide:
- Gather Property Details:
Start by collecting all the paperwork related to your property, like blueprints, purchase invoices, and any records that show the costs involved in buying or constructing the property. The more detailed you are here, the better. - Identify and Classify Assets:
Here’s the tricky part—deciding what’s considered personal property (like carpets, appliances, or lighting) versus structural components (like walls and the roof). You’ll need to follow IRS guidelines to separate these items. Think of it like creating categories for your property’s features so they can be depreciated over different timelines. - Use Tools and Software:
There are online calculators and cost segregation software tools out there that can help you estimate your depreciation. These tools can give you a rough idea of how much you can save, but be aware that they’re not always as detailed as working with a pro. - Document Everything:
Keep track of everything, blueprints, invoices, and classifications. Why? Because if the IRS comes knocking, you’ll need a solid paper trail to back up your claims. Good documentation is key to avoiding issues down the line.
When Should You DIY vs. Hire a Pro?
- DIY:
If you’re working with a simple residential property or a small business, you might be able to handle the cost segregation study on your own. The savings here might not be huge, but the effort could pay off. - Hire a Pro:
For complex commercial properties or larger-scale investments, it’s usually worth hiring a professional. Why? A pro can navigate the complicated rules and ensure you don’t miss out on valuable deductions. Plus, if you’re dealing with significant savings, the cost of a professional might more than pay for itself.
Be careful because cost segregation studies can get tricky, especially when it comes to classifying assets correctly. If you’re ever in doubt or the property is complicated, it’s a good idea to consult a tax professional. Even small mistakes can cost you big later on, especially if the IRS questions your deductions.
Pros and Cons of Cost Segregation Studies
| Pros | Cons |
|---|---|
| Big Tax Savings Fast-tracked depreciation gives you larger tax deductions now. |
Upfront Costs Professional studies can cost $5,000 to $15,000. |
| Increased Cash Flow More savings upfront means more money to reinvest in your property or business. |
Complex Process Understanding and classifying assets can be tricky if you do it yourself. |
| Flexibility with Taxes Adjust your tax strategy to suit your financial needs. |
Potential for Mistakes If done incorrectly, you could miss out on deductions or face penalties. |
| More Money for Growth Reinvest the savings into expanding your business or property. |
IRS Scrutiny Accelerated depreciation might raise questions with the IRS. |
| Improved Return on Investment (ROI) Increased savings and cash flow can boost the overall profitability of your property. |
Limited to Large Properties Smaller properties may not benefit as much from a cost segregation study. |
Maximize Your Savings with Cost Segregation and LoomLease
A cost segregation study can unlock significant tax savings and improve cash flow for property owners by accelerating depreciation. Whether you do it yourself or work with a professional, understanding how the process works can help you save thousands.
With LoomLease, managing the financial side of your rental properties becomes effortless. Our property management software streamlines tracking depreciation, maximizing tax savings, and simplifying your overall financial strategy.
Ready to make your property management easier? Start your free trial of LoomLease today!