Cost segregation is a strategic technique that allows companies to maximize tax allowances by accelerating depreciation on commercial property. In reality, companies are simply separating personal property from the real property within their real estate.
Personal property is depreciated over a period of 3, 5, 7 or 15 years, while real property is depreciated over a period of up to 39 years. The purpose of conducting a cost segregation analysis is to identify property components and related costs and then reclassify them into their correct category, allowing companies to "catch-up" on previously under-reported depreciation. This can be accomplished without having to amend prior tax returns.
Major benefits include:
The IRS has approved six Cost Segregation methods:
Personal Property - Typically depreciated over a period of 3-15 years using the double declining method. Items in this category may include furniture, carpeting, certain fixtures and fittings and window treatments.
Real Property - Normally depreciated over a period of up to 39 years. Items in this category may include land improvements, buildings and land (details below).
Land Improvements: Normally depreciated over a 15-year period using an accelerated or 150% declining balance method. Items in this category may include sidewalks, fences and docks.
Buildings: Although a building's separate components are considered part of the building itself, it is advantageous to value and depreciate each component separately. For example, if a building component becomes worthless, it can be immediately written off (fully depreciated), e.g. roofing.
Land: The remaining value, not falling into the two real property categories above, is allocated to land.