Tax Reduction Benefits of Cost Segregation

Tax reduction and tax deferral are the primary benefits of obtaining a cost segregation study. Tax reduction occurs since more income is taxed at the capital gains rate instead of the ordinary income rate. Tax deferral occurs since depreciation is accurately taken in the early years of ownership.

Additional benefits other than tax reduction related to obtaining a cost segregation study are more accurate accounting, obtaining a book value for assets which may become worthless (tenant improvements for a financially unstable tenant) and an accurate method of tracking the cost basis and depreciation for all tenants.

Tax reduction is the most meaningful and least understood benefit of cost segregation. Consider the following example of how cost segregation converts income taxed at 35% to income taxed at 15%:

Linda is a physician who earns $350,000 per year. She purchased a medical facility in January 2004 and sold it in December 2005. Her cost segregation study increased the amount of depreciation by $80,000 in both 2004 and 2005. The higher level of depreciation decreased Linda’s income taxes by $28,000 in both 2004 and 2005, for a total reduction of $56,000 (based on ordinary income). However, Linda’s capital gains income will increase by $160,000 in 2005, based on two years of additional depreciation ($80,000 per year X 2). The additional capital gains tax will be $24,000 ($160,000 X 15% capital gains rate). Hence, Linda’s net income experiences a tax reduction of $32,000 ($56,000 - $24,000) over just a two-year period. This analysis does not consider the time value of money.

Real estate investors will generally benefit by obtaining a cost segregation study if the cost basis of the property is at least $500,000.

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Cost segregation produces tax deductions and reduces federal income taxes across the country and in every size market. Below are just a few examples of where cost segregation generates meaningful tax deductions.

City:

• Houston, TX
• Hartford, CT
• Miami, FL
• Las Vegas, NV
• Atlanta, GA
• Bridgeport, CT
• Orlando, FL
• Los Angeles, CA
• Denver, CO
• New Orleans, LA
• Louisville, KY
• Raleigh, NC
• El Paso, TX
• Sacramento, CA
• Ft. Lauderdale, FL
• Albany, NY
• Riverside, CA
• Portland, OR
• Buffalo, NY
• Detroit, MI
• Toledo, OH
• Augusta, GA
• Scranton, PA
• Wichita, KS
• Chicago, IL
• Honolulu, HI
• Lakeland, FL
• Kansas City, MO
• Pittsburg, PA
• Nashville, TN

Cost segregation produces tax deductions for virtually all property types.

Property Type:

• Motel
• Community shopping center
• Auto service garage
• Neighborhood shopping center
• Tennis club
• Single-tenant retail
• Bank
• Country club
• Truck stop
• Medical office

Almost every industry, including the following, can generate cost-efficient tax deductions by using cost segregation.

Industry:

• Paper manufacturing
• Printing activities
• Truck transportation
• Electronic and appliance stores
• Fabricated metal products
• Food manufacturing
• Durable good wholesalers
• Automotive parts distributors
• Frozen food manufacturing
• Air transportation

O’Connor & Associates is a national provider of commercial real estate consulting services including , cost segregation services, due diligence, renovation upgrading cost analyses, income taxes, tax return review and apartment inspections.

Patrick C. O'Connor has been president of O'Connor & Associates since 1983 and is a recipient of the prestigious Mai designation from the Appraisal Institute.