Answering 6 Common Concerns Regarding Cost Segregation Studies

6 Common Concerns Regarding Cost Segregation Studies:

1. Increased chance of an audit

The IRS encourages cost segregation studies as long as they are done following established rules, a fact that frequently surprises taxpayers. The IRS Field Audit Techniques Guide (ATG) lists various requirements for high-quality research and reports and refers to these standards. The ATG includes industry-specific information, issue-specific guidance, and court judgments about cost segregation. Skilled collaborators can construct solutions that resist IRS inspection and correctly understand the tax legislation around cost segregation.

2. Confusion around the timing difference

While a building’s value will degrade to its total value in 27.5 or 39 years, the cost segregation studies reclassify them into asset classes with shorter recoveries, including 5, 7, and 15 years. In doing so, significant deductions are generated early in the asset’s life, utilizing the time value of money. In the long run, current deductions will be far more beneficial than those made later. Given how quickly inflation is rising, this time differential is more critical than before. Property owners can reinvest the savings from a cost segregation study into their firm, yielding a more significant return than a depreciation deduction if the property had been left in the previous 27.5 or 39-year recovery period.

3. Recapturing Depreciation

Depreciation recapture is another issue that frequently brings concerns around cost segregation. Any depreciation accelerated due to the cost segregation study may be recovered by the IRS when a property is sold. The taxpayer’s ordinary income tax rate, often higher than the capital gains tax rate, applies to the recaptured amount. As a result, property owners may have serious concerns about paying more taxes when selling their properties.

4. Cost and complexity of performing a study

For many property owners, the expense of performing a cost segregation analysis might be a significant worry. These studies may be costly since they need a thorough grasp of building techniques, tax regulations, and the particular company sector.

Studies on cost segregation are inherently complicated. This intricacy can be daunting for property owners, particularly those unfamiliar with the nuances of cost segregation.

5. In a resell, cost segregation might cost more because of recapture

Even if a property owner intends to sell the property in the future, cost segregation studies can result in long-term tax savings; nevertheless, to fully benefit from the research, a property should generally be retained for three to five years after it is finished. These principles are a helpful place to start when preparing, while the holding period varies depending on each case. 

The possibility of a recapture-related tax increase at the time of sale shouldn’t deter property owners from doing a cost segregation analysis. The higher tax from recapture is frequently outweighed by the improved cash flow from the accelerated depreciation deductions, which offset ordinary income. This is because recapture is only allowed for the profit from the property’s sale. The value of personal property decreases from the moment it begins to depreciate until it is sold.

6. Agreement Between Partners

Various partners may have different opinions on carrying out a cost segregation study when multiple partners hold a property. While some partners could be eager to take advantage of possible tax savings, others might be cautious because of the upfront expenses or potential audit concerns. These distinctions might cause delays or confrontations, which makes decision-making more difficult.