Tax Strategy Series - What is Cost Segregation? Pros and Cons

Cost segregation allows the taxpayer to identify property that is part of an asset class with a shorter recovery period and take the appropriate depreciation. This leads to larger deductions in early years of the property.

Property such as a commercial building or a rental property have longer property lives and recovery periods than tangible property. Residential rental property has a property life of 27.5 years, while nonresidential real property has a property life of 39 years.

Cost Segregation Study

▪ For property valued at $500K, a cost segregation study is required.

▪ Experts evaluate the property and break down what parts of the property are “structural components” and what parts could be considered “Section 1245 Property.”

▪ The “Section 1245 Property” is then given the appropriate asset class as determined by the IRS, with the corresponding recovery period.

▪ The evaluation is compiled with an explanation of the methodology used.

▪ Property that qualifies for a shorter recovery period can be depreciated at an accelerated pace, leading to larger deductions in earlier years!

Implementation

▪ Schedule a Cost Segregation Study if necessary

▪ Bonus depreciation (if qualified) is the default method under current law

▪ Reported on Form 4562, Part II

▪ 179 Expensing is reported on Form 4562, Part I

▪ Elections to use a different method are also made on Form 4562

▪ Elections flow through to the return - 1120, 1120S, 1040, etc.

▪ If property has already been placed in service and accounting changes are being made, a Form 3115 will also be required

Resources

▪ IRS Publication 946

▪ Form 4562 and Instructions

▪ Rev. Proc. 87-56; Rev. Proc. 88-22

▪ IRS Cost Segregation Audit Techniques Guide

▪ The Hospital Corporation of America v. Commissioner, 109 T.C. 21 (HCA)

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