Cost Segregation - Tax Deductions

By understanding business tax deductions, business owners may enjoy personal benefits from business expenditures - a nice car to drive, a combination business trip/vacation, retirement savings plan - if they follow the myriad tax rules.

The tax code allows deductions from gross income, which reduce income taxes. Increasing tax deductions reduces taxable income and income taxes. Therefore, knowing how to maximize your deductible business expenses enables you to lower taxes.

According to the IRS, trade or business expenses must be ordinary and necessary to be considered a tax deduction. Although the tax code does not specifically define "ordinary" and "necessary" tax deductions, these types of expenses are specified in various IRS publications and regulations. Some of the tax deductions business owners can claim fall under categories such as charitable contributions/donation deductions, medical and dental deductions, moving expense deductions, deducting job costs, travel and entertainment expense deductions, casualty and theft losses, depreciation and involuntary conversion deductions.

Even after the fiscal year ends, and business owners of improved commercial real estate are still seeking tax deduction opportunities, one popular option is to order a cost segregation study (CSS). A CSS will identify any item that can be depreciated over a shorter period of time. These studies can result in accelerated depreciation deductions for properties including new buildings, renovations of existing buildings, leasehold improvements, and real estate purchase after 1986. Cost segregation allows business owners to increase depreciation, generate more tax deductions, and reduce their tax rate.

Cost segregation involves separating up to 135 components of real estate that depreciates faster than the building itself. Taxpayers can depreciate many components of real estate using a five-, seven-, or 15-year recovery period. Within permissible bounds, there is a huge tax-savings opportunity for valuing this property accurately. This category includes items such as carpeting, certain fixtures, window treatments, site improvements and some wall coverings.

Cost segregation increases tax deductions by apportioning about 20% to 40% of the total cost basis to short-life property. Short-life property depreciates over a shorter life period and provides a higher level of tax deductions annually during the first 15 years of ownership. Most business owners increase depreciation by 50% to 75% by obtaining a CSS analysis.

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.