Definition of "Cost Segregation Study"

If you’re in the business of purchasing properties, maybe as a real estate investor, you might be wondering what is cost segregation. Well, first of all, it’s a study that deals with the depreciation of properties. The cost segregation study definition is a strategic tool for tax planning that allows entities that deal with building, purchasing, expanding, or remodeling of real estate properties to accelerate the depreciation deductions of assets and to defer some federal and state income taxes. This helps companies to invest funds that are deducted from taxes back into the company.

What is the Cost Segregation Study and what does it mean?

Through a cost segregation study, a company can analyze all the assets belonging to a property of any type and separate them from the property itself. Like this, the assets will be grouped into personal property assets and real property assets. This means that once the two are separated, they can be analyzed separately.

Now, why is this even necessary?

The reason is simple, depreciation. The basic principle of depreciation allows some types of assets to depreciate differently than others. For example, a real property asset (meaning the property itself, walls, roof, and so on) depreciates during a period of 27.5 and 39 years. When you look at a house, however, you don’t only see the house’s structure. There is a wall covering, carpets, indoor and outdoor lighting, or other improvements or elements of the initial structure. Those are considered personal property assets. 

The reason why cost segregation studies are done is that through it, the cost segregation specialist can determine the cost of the personal property assets. As we already mentioned, depreciation affects these assets differently. What differs are the years needed for them to be depreciated. The depreciation span of personal property assets varies between 5, 7, or 15 years.

You’re already wondering who can do a cost segregation study? Well, they are known as cost-segregation specialists, but more often than not, they are construction engineers. You should know, however, that the cost of a cost segregation study is somewhere between $10,000 and $25,000, depending on the location, size, age, and nature of the property. The reason why somebody would spend that money is for accelerated depreciation.

How does a Cost Segregation Study work?

During the analysis, the cost-segregation specialist dissects the property to determine the personal property assets that can be depreciated. The process is a non-intrusive study that will look beyond the building’s walls for the plumbing, the electrical systems, cooling, heating, telecommunications, flooring, ceiling, and lighting to state a price for all those little or big investments. With this information on hand, the owner, investor, company, or other entity can claim tax deductions through accelerated depreciation

The reason why most, or the best, cost-segregation specialists are construction engineers is that they have a more accurate understanding of the values of those assets. Within the study, the cost of architectural and engineering work is also included as a personal property asset.

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