Apartment Building Cost Segregation Analysis

by | BiggerPockets.com

Cost Segregation

One of the great advantages of commercial property investing is the tax benefits. The IRS has a program that allows the owners of apartment buildings or any other commercial property to increase the level of accelerated depreciation allowed in a tax year.

The tax savings may go back to property acquired after 1986, and they apply to new or future construction. They also extend to existing buildings under renovation, expansion and leasehold improvements, as well as to property about to be acquired. It can also be used for financial accounting, insurance and property tax purposes. The primary goal of a cost segregation study is to identify all construction-related costs that qualify for accelerated income tax depreciation. Cost segregation is not a tax shelter and it is not tax evasion.

Ask Yourself These Questions To Determine if You and Your Property Qualify:

Do you own a commercial property valued at $500,000 or more?

Do you pay federal income taxes?

Do you operate a corporation or entity that is for-profit?

Are you planning to the hold the property for more than one year?

To Obtain the Benefits of Cost Segregation You Must Get a Study

Your cost segregation study will analyze the taxes and costs incurred to buy, construct or renovate any kind of commercial real estate. You will need to procure the services of an expert or CPA to conduct the study. The CPA will dissect the costs to determine the accelerated income tax schedules. In order to meet the minimum qualifications of a cost segregation study, property owners must be taxpayers or intend to pay taxes. The cost of a study can range between $10,000 and $100.000.00 depending on the size and complexity of the project.

Advantages of Cost Segregation

  • Considerable return on investments property that do not need to be insured.
  • Increased tax deductions for depreciation and reduces taxable income.
  • Opportunity to correct misclassified assets and claim “catch-up” tax deductions.
  • Ability to achieve faster building and acquisition cost write offs.
  • Reduction in insurance costs by identifying the components of the property that do not need to be insured.
  • Determine personal property versus real property for write off versus capitalization prior to construction. This allows you to write off these items opposed to capitalizing the assets. This can provide you with huge tax benefits.
  • Defers taxes on capital gain amounts until the property is sold.
  • Reduces real estate property taxes.
  • Reduces federal income tax and increases depreciation.

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  1. Ted, good article — but I believe your statement “Do you own a commercial property valued at $500,000 or more?” was far too limiting. We’ve found two companies that can do the job on Single Family Residences costing $160,000 for as little as $650. At this level the work easily pays for itself (at least on GO zone properties). While in general I found most Chattel Analysis companies will only work on “large” projects, some in fact do handle smaller properties. There are quite a few good articles out there on the net…

    • Suly B.

      Tim, good point! In the past, cost segregation studies had a bad reputation of being complex and really expensive. Fortunately, there are companies that will do a cost seg study on real estate valued less than $500,000. My company,Titan Engineering, developed and designed a software (Titan Echo) specifically for making the entire process simpler, more affordable and defensible. $400 for Do -It- Yourself using our software and $1,000 for us to do the entire thing. Either way we don’t want the smaller properties to be overlooked.

  2. Most CPA’s are not qualified to do cost segregation studies and have to obtain the services of a qualified engineer (required by IRS), which many do not have access to.

    Most CPA’s and Tax professional also feel that doing cost segregation studies on projects this small, will not bring much of a return. This is the reason engineering companies will only take on larger projects. Be cautious about companies that say they can do a property study for $650 for a project this small, you just may be throwing away money. Something you may consider is consulting a company that actually has a business and tax law consultant (attorney), before choosing a company to do a study on a project this small. If they are a reputable company they should offer you a free consultation before you spend any money upfront, in order to determine the approximate dollar amount of your cost segregation refund.

    • Suly B.

      Sharon, I agree that every savvy investor or their CPA should research the company that offers cost seg studies 1st and foremost. The company I’m with offers free benefit estimates and we always advise investors to run it by their CPA before moving forward with a project. After all, their CPA knows their unique financial position best so he or she can determine if the savings will benefit their client.

  3. Nice article, Ted, but a CPA is NOT qualified to perform cost segregation. The CPA most certainly can apply the results, however, but the IRS recommends (not requires) those “competent in construction methodology or techniques” perform the study.

    Cost segregation identifies those assets that qualify for reclassification. Quite often that requires observation of how the asset is being used or it’s intended purpose. For example, an HVAC system is a 39-year asset by application and nature; however, when it is installed for the sole purpose of cooling a computer server/communications room, it becomes a 5-year asset by application. Also, “how” an asset is built or integrated into the building design can determine it’s asset class. For example, a retaining wall attached to a building is a 39-year asset; however, installing an expansion barrier between it and the building allows it be classified as a 15-year asset under land improvements and depreciated on a 150% declining balance MACRS method.

    Regarding “chattel” studies, which are, in essence, cost segregation studies, they are applicable to any residential rental property regardless of it’s value. Of course, the determining factor as to whether it is suitable is up to the property owner. Most chattel study companies charge from $500 to $1500 for single SFR studies with some discount for multiple studies simultaneously. Sharon Clay’s position is incorrect on the point of a “small study” for $650. If the $650 study results in an extra $10,000 to $15,000 in accelerated depreciation at a 30% tax bracket, the tax credit is $3,000 to $4,500. Who wouldn’t trade $650 for $3,000? And what reputable company doesn’t offer free estimates?

    We perform cost segregation studies on any property, owned or leased, down to $100,000 in fixed asset value. Of course, the final arbiter of value is the property owner…if they’ll trade a dollar to get two, then why not apply it?

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