Discover how cost segregation for commercial real estate can maximize tax savings, improve cash flow, and accelerate depreciation on lighting, flooring, and more. Learn about reclassifiable components and unlock expert guidance with Maven Cost Seg.
6 min read
Overview
Cost segregation is a highly effective tax strategy that allows commercial property owners to accelerate depreciation and reduce their taxable income. By identifying building components that qualify for shorter depreciation periods, owners can front-load deductions and improve cash flow. For commercial real estate, this process is particularly beneficial due to the variety of components that may be reclassified under IRS guidelines.
This reclassification aligns with IRS guidelines outlined in Revenue Procedure 2019-33 and the Cost Segregation Audit Technique Guide (ATG). By leveraging this strategy, property owners can reduce their current-year tax liabilities while preserving long-term value.
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Cost segregation is particularly impactful for newly constructed buildings or recently acquired properties, as these scenarios often involve a higher percentage of qualifying assets.
In a cost segregation study, eligible components are separated from the 39-year property class and reclassified into shorter depreciation categories. Below are examples of reclassifiable components common in commercial properties:
These reclassifications must comply with IRS rules, and accurate documentation is critical to avoid audit risks. Professional expertise ensures that all eligible components are properly identified and valued.
This category includes items that are movable and not structural, such as decorative lighting, carpets, and specialized wiring.
This includes office furniture, communication equipment, and tangible personal property not covered under 5- or 15-year categories.
This includes land improvements like sidewalks, parking lots, landscaping, and outdoor signage.
Timing Considerations: Cost segregation is most beneficial in the following scenarios:
Compliance Requirements: The IRS requires detailed documentation to support cost segregation claims, including engineering-based studies and supporting calculations. Failure to meet these standards may result in disallowed deductions or penalties.
Cost segregation has proven effective across various types of commercial real estate. Below is an example illustrating the potential savings: Case Example:
A 25,000-square-foot office building was purchased for $5 million. A cost segregation study identified $1.5 million in assets eligible for accelerated depreciation.
This accelerated depreciation significantly improved cash flow, allowing the owner to reinvest in additional projects.
| Year | Standard Depreciation (39-Year) | Cost Segregation Depreciation | Additional Savings |
|---|---|---|---|
| 1 | $128,205 | $600,000 | $471,795 |
| 2 | $128,205 | $450,000 | $321,795 |
| 3 | $128,205 | $300,000 | $171,795 |
| 4 | $128,205 | $200,000 | $71,795 |
| 5 | $128,205 | $150,000 | $21,795 |
| 6-10 | $641,025 | $250,000 | -$391,025 |
While cost segregation is a valuable strategy, errors can undermine its effectiveness. Common pitfalls include:
These issues highlight the importance of engaging qualified professionals who understand both engineering and tax regulations.
At Maven Cost Seg, we take a detailed and compliant approach to cost segregation:
Cost segregation is a critical tool for commercial real estate investors seeking to optimize their tax strategy. By accelerating depreciation on qualifying assets, property owners can improve cash flow, reduce tax liabilities, and enhance their overall ROI. To maximize the benefits of cost segregation, understanding IRS requirements and engaging qualified experts is essential. Maven Cost Seg provides engineering-driven solutions that help property owners unlock their full tax-saving potential.
| Property Category |
Description | Examples |
|---|---|---|
| 5-Year Property |
Items not integral to the building structure and easily movable. |
Decorative lighting, removable flooring, window treatments, movable partitions, security cameras, data cabling, specialized wiring for equipment. |
| 7-Year Property |
General tangible personal property not categorized as 5- or 15-year. |
Office furniture, communication equipment, computers, printers, audio systems. |
| 15-Year Property |
Land improvements outside the building structure. |
Sidewalks, parking lots, landscaping, fences, stormwater drainage systems, retaining walls, external signage. |
About the Author
Sean Graham, CPA specializes in cost segregation, tax depreciation, and real estate tax savings. As the Founder and CEO at Maven Cost Segregation: Tax Advisors, he has overseen 1000+ cost segregation studies, helping investors maximize deductions.