Intro to Cost Segregation

Cost Segregation is the practice of identifying personal property assets and their costs and classifying those assets for federal tax reporting purposes.

Most experienced real estate investors know that the IRS allows different types of property to be depreciated at different rates. An apartment complex owner is allowed to write off “short life assets” (such as carpets, roofing, HVAC, etc.) at different rates than the structural or “real asset.” The study that officially determines these differing value and depreciation schedules is called a Cost Segregation Study.

The Process

A Cost Segregation Study can be completed by a specialist performing a detailed engineering study on the property. Keep in mind, not all "specialists" are created equal. The IRS states: "The preparation of cost segregation studies requires knowledge of both the construction process and the tax law involving property classifications for depreciation purposes. Unfortunately, there are no prescribed qualifications for cost segregation preparers. However, a preparer’s credentials and level of expertise may have a bearing on the overall accuracy and quality of a study.”¹

"In general, a study by a construction engineer is more reliable than one conducted by someone with no engineering or construction background. However, the possession of specific construction knowledge is not the only criterion. Experience in cost estimating and allocation, as well as knowledge of the applicable tax law are also important criteria.”¹

It's important to thoroughly research specialists and choose those with a proven track record and a deep understanding of producing "Quality" Cost Segregation Studies as outlined by the IRS.¹ Next week we'll discuss the benefits of Cost Segregation Studies and how some investors pair them with a tax-deferred 1031 exchange.

^{1. https://www.irs.gov/businesses/cost-segregation-audit-technique-guide-chapter-4-principal-elements-of-a-quality-cost-segregation-study-and-report}