COST SEGREGATION STUDIES DEFER INCOME TAXES, THEY DON’T ELIMINATE THEM…

COST SEGREGATION STUDIES DEFER INCOME TAXES, THEY DON’T ELIMINATE THEM…

BUT THEY DO HELP YOUR CASH FLOW!!!

PART I OF II…

I have been writing about Cost Segregation Studies for a long time and there seems to be a misconception about what a Cost Segregation Study does. I don’t think that the misconception comes from me, it comes from all the people who write articles here and on LinkedIn who say that you can eliminate income taxes through using Cost Segregation Studies. What a Cost Segregation Study does is to defer income taxes, it does not eliminate them just like so many people have written here before.

First, what does a Cost Segregation Study do. It segregates the property, the commercial real property, that you purchase to use as a vehicle to make money. Examples are multifamily housing, self-storage facilities, shopping malls, strip shopping centers, and I could go on for a week among land, structure, and Tangible Personal Property. Land does not ever get depreciated because it is never going to be used up. Land gets depleted like a gold mind. As you take the gold out of the mind there is less and less gold left until there is none left and that is called DEPLETION!!! THAT IS NOT DEPRECIATION!!! The textbook definition of DEPRECIATION, and I was a University Professor for 6 ½ years, is the systematic allocation of the cost of a fixed, non-monetary asset, over the time or period of benefit.

Who determines the “period of benefit”? Sometimes the user determines the period of benefit because they have used this item before and they know how long it takes for it to be used up. Sometimes the manufacturer. Sometimes the Internal Revenue Code!!! The Internal Revenue Code says that Residential Real Estate should be depreciated over 27.5 years. Non-residential real estate should be depreciated over 39 years. Some pieces of Tangible Personal Property should be depreciated over 5, 7.5, and 15 years.

So, let’s go back to our example of buying an apartment building used as a commercial building. You buy land, which is not depreciated, the structure which is depreciated over 27.5 years and the tangible personal property which could be depreciated over various periods of time. But, now let’s bring in a new term and that is Bonus Depreciation. Instead of depreciating tangible personal property over several different periods of time you can take all of the Bonus Depreciation, to be overly simplistic, in the year that the asset is placed in service. So, you are taking ALL of the depreciation of the tangible personal property in 1 year.