Cost segregation continues to be an essential tax planning tool in 2024. By accelerating the depreciation allowed on a building, taxpayers can significantly reduce their taxable income in the initial years of property ownership. This strategy offers a substantial reduction in taxes, thereby boosting cash flow during the crucial early years of owning a building.
Understanding Depreciation and Its Benefits
Depreciation is a yearly write-off of the purchase cost of a building. This deduction reduces your taxable income, leading to lower tax payments. When you purchase a building, you can write it off over 39 years (or 27.5 years for a residential building). For instance, if you buy a building for $7,500,000, you could typically expect an annual write-off of about $110,000, assuming the building constitutes 60% of the purchase price.
The Power of Cost Segregation
A cost segregation study can break down the building into components with shorter depreciation lives, such as 15, 7, or 5 years. This is achieved through an engineering study that identifies which parts of the property can be separated from the main structure. As a result, the annual depreciation might increase to $160,000 instead of $110,000, providing an additional $50,000 deduction in the first year. While the total depreciation remains $4,500,000 (60% of the $7,500,000 purchase price), you benefit from a larger portion of the deduction earlier on.
Savings Vary by Building Type
The savings from a cost segregation study can vary significantly depending on the type of building and its contents. For example, a shopping center might yield different savings compared to an industrial facility. Buildings with more 5-year property will see greater savings in the first five years, whereas buildings with primarily 15-year property may see smaller benefits.
Offsetting Deduction Limits
Recent years have seen limits on various deductions, such as interest expenses and research and development (R&D) expenses. Accelerating depreciation through cost segregation can help offset these limitations, providing a valuable tax relief option.
Enhancing Cash Flow Amid Higher Interest Rates
Higher interest rates can reduce the cash generated from investment properties. By front-loading depreciation, cost segregation can help recover some of this lost cash by reducing tax liabilities, thus improving cash flow.
Combining Cost Segregation and Business Operations
For owner-occupied buildings, an election can be made to group activities, using additional deductions from real estate and cost segregation to offset higher income resulting from these deduction limits. This strategy can be particularly beneficial in managing the tax impact of these expenses.
At LSL, we explore every possible option to maximize our clients’ benefits. If you’ve seen an increase in taxes and a decrease in cash flow, give us a chance to review your situation. Our expertise in cost segregation can help you optimize your tax strategy and improve your financial outcomes.
Contact us today to learn more about how cost segregation can benefit your specific situation and enhance your investment returns.
