Cost segregation is a strategic technique utilised by businesses in the US to maximise their tax allowances, by using accelerated depreciation on real properties.
When a company performs cost segregation, what they’re actually doing is identifying personal property assets that are grouped with real property assets and then just separating then out within their real estate. The reasoning behind this is that personal property has depreciation schedules of 3, 5, 7 and 15 years, as oppsed to real property which is depreciated over a period of time up to (and including) 39 years.
The reason for this depreciation accounting, and for conducting the cost segregation in the first place, is to highlight property elements and related costs in order to reclassify them into their correct category. This means companies can catch-up on previously under-reported depreciation, without having to amend previous tax returns. Other reasons to utilise cost segregation include increased tax credits along with reduced real propety taxes; thus improving post-taxation cash flow.
There are five fixed asset categories relating to cost segregation:
Personal property, which generally refers to items such as furniture, carpets, fixtures and fittings
Real property, which tends to include land and structures (i.e. buildings)
Buildings, which is usually split into building components, allowing companies to fully depreciate one component (such as the roof or windows) without depreciating the whole building
Land improvements, generally referring to things like fences, pavements, etc. which have a normal depreciation schedule of 15 years.
Land, generally refers to anything remaining (of value) that doesn’t fall into any of the above real property categories.
So how does a property become eligible for cost segregation? Generally, the rules are that they must have been built, purchased or remodelled since 1987 and although it’s not a rule, it’s generally considered not worth the effort for buildings costing less that $200,000.
It’s well worth studying the properties in your business and seeing if you can benefit from cost segregation; all you’ll need is an accountant and an engineer to analyze architectural drawings, blueprints and electrical plans and begin to segregate the structural and general building, electrical and mechanical components from those fixed assets related to personal property.
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