Cost segregation is a tax planning strategy used by real estate investors to accelerate depreciation deductions on their properties. When you purchase or construct a commercial property, the IRS typically requires you to depreciate the entire cost of the property over a lengthy period, commonly 27.5 years for residential rental properties and 39 years for commercial properties.
However, cost segregation allows you to break down the property’s cost into shorter-lived assets, such as personal property or land improvements, which have shorter depreciation periods. By doing so, you can front-load the depreciation deductions, resulting in higher tax deductions in the earlier years of ownership.
For example, instead of depreciating the entire cost of a building over 39 years, a cost segregation study may identify certain components, like lighting, flooring, or specific equipment, that can be depreciated over 5, 7, or 15 years. This can provide significant tax benefits by reducing taxable income and increasing cash flow in the earlier years of owning the property.
It’s important to note that cost segregation is a complex process and typically requires the expertise of specialists in cost segregation studies, to accurately identify and allocate the costs associated with different components of the property. Additionally, the tax laws and regulations related to cost segregation may change, so it’s advisable to consult with tax professionals to ensure compliance and maximize the benefits of this strategy.
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