There are many new tax benefits available for small businesses, but companies need to ensure that they are fully taking advantage of these new laws. One effective strategy that companies sometimes do not fully utilize is cost segregation. Cost segregation is an excellent strategy to help companies increase their cash flow and maximize tax savings. Cost segregation for businesses is a complex topic, as companies need to keep up with ongoing developments and ensure that decisions align with their financial objectives.
How Can Cost Segregation Benefit My Business?
Cost segregation is an important strategy for businesses, as it can allow them to more rapidly depreciate certain assets. This strategy is an excellent choice for businesses that are about to invest in commercial property.
Commercial real estate buildings are depreciated over 39 years, while the cost of purchasing land is non-depreciable. However, you can depreciate certain components of this investment at a quicker rate. In many cases, some of the investment components can be depreciated over five, seven, or 15 years, resulting in ample tax savings during these initial years.
This strategy can benefit companies in many ways. By rapidly depreciating assets during the first 5-15 years, companies can enjoy great tax savings in these years. These tax savings can help free up additional capital, which the company can use for operational expenses or additional investments, if necessary. If a business is on the fence about whether it can make a certain investment, a cost segregation strategy could be one move that could potentially make it easier for the company to afford the project and understand the financial implications.
When is Cost Segregation Most Effective for Businesses?
Cost segregation is most effective for businesses that are about to make larger investments in commercial real estate. In particular, if companies plan to make investments in things like furniture, fixtures, and equipment ( FFE) and land improvements, cost segregation can be helpful. Expenses like these can be depreciated over a shorter period, and can sometimes make up a large percentage of the total investment. Moreover, companies may be able to classify investments like water lines and waste lines as personal property to receive further tax savings.
Businesses that use cost segregation may be constructing a new building, making an acquisition, or renovating an existing property. This strategy is most effective for companies that need to make this investment and could benefit from tax savings to boost their cash flow. In general, cost segregation can benefit most businesses if they are sure they want to make a new investment.
However, if a company is currently able to carry over losses from other years, or is not in dire need of making a new investment, it may not have the strongest effect on the company’s financials. Moreover, if a company plans to sell the property soon, it may not be worthwhile to perform a cost segregation study.
Businesses should also consider Section 179, which can provide even more tax savings benefits. This benefit can allow some businesses to immediately deduct 100% of eligible expenses, resulting in massive tax savings during the first year.
What Business Properties are Best Suited for Cost Segregation?
Some of the most common types of properties that can benefit from cost segregation include manufacturing plants, retail spaces, and office buildings. Many of these projects have diverse asset components, so a large percentage of the investment can be depreciated over 7-15 years. Various types of upgrades, such as carpeting, electric systems, and other upgrades, are classified differently and can be depreciated over a shorter period.
Many industries stand to benefit from cost segregation, especially companies that are making larger investments with a lot of components that can be classified as personal property. Hospitals are also excellent targets for Section 179D, which is a commercial energy-efficiency tax benefit. They can also rapidly depreciate various types of specialized equipment, such as MRI machines. Hotels can also strongly benefit from cost segregation, as they typically need to make stronger investments in personal property, which can be rapidly depreciated. Moreover, real estate developers may stand to benefit significantly if they build units with commercial and residential units, as residential units can be depreciated over 27.5 years instead of 39 years.
Overall, many companies stand to benefit from cost segregation if they are working on a large project. For example, if a company makes a massive investment in a commercial real estate building, it would generally have to depreciate the entire investment over 39 years. However, the company may be able to classify some of the investment as a land improvement and depreciate this over 15 years. Furthermore, it can also make interior fixtures, and depreciate all of these expenses over 5 years. These benefits are much more pronounced, as the tax savings are negligible when an asset is depreciated over 39 years.
How to Get Started with Cost Segregation for Your Business
Determining when to use cost segregation can be a challenging task, as you will need to analyze your business’s financial condition, consider the potential tax benefits, and stay up to date with new tax laws.
One of the best initial steps is to meet with a tax advisor to see if it is worthwhile to pursue a new project because of the tax benefits. For smaller construction projects, the tax savings from cost segregation may be negligible, and it may not be worth the time and effort of conducting a cost segregation study.
A lot of the tax laws, such as Section 179 and bonus depreciation, may be changing in the coming years, so it is crucial to use a tax advisor to stay up to date with these changes. Moreover, performing a cost segregation study can help you ensure that you have a strong third-party review in case the IRS needs to audit this information.
This step can ensure that you remain compliant and do not miss out on tax benefits, which can significantly help you for many years after this investment.
Closing Thoughts on Cost Segregation Study Preparation
Preparing a cost segregation study can be a solid step to help your business save money on taxes. For many businesses that invest in commercial real estate, there are plenty of ways to more rapidly depreciate some of the investment components, resulting in tax savings during these initial years.
Consulting with a tax advisor can help you ensure that you remain compliant and take advantage of some of the tax benefits of cost segregation. This method can help improve your company’s financial performance, as it can free up additional cash for you to invest or pay for other operational expenses.
As the tax laws continue to change in the coming years, it is crucial to stay abreast with new developments to remain compliant and take advantage of new tax incentives. Moreover, it is also very important to have a cost segregation study that is strong enough to withstand scrutiny from the IRS.
