Half-truths, misconceptions, and myths fly about our world like a colony of “blind” bats awakened for the night: Napoleon was short, don’t wake a sleepwalker, you can see the Great Wall of China from space, the ‘five-second rule,’ duck quacks don’t echo, bulls hate red…
But thanks to using more than 10 percent of our brains to delve deeper into these misguided notions, we’ve displaced falsehoods with facts. Yet, despite these discoveries, there exists little pockets of myths that continue to hide away, escaping our awareness, like so many ostriches with their heads in the sand (another myth).
Cost segregation is one of those territories that still harbor its share of misconceptions and fiction. So we’re inviting you to join us in our quest to uncover cost segregation truths - or face the consequences of perpetuating the fiction: missed opportunities for substantial tax savings and expedited cash flow.
To Tell the Truth About Cost Segregation
1. Fiction: My building is too small to benefit from a cost segregation study
Fact: Yes, a cost segregation analysis does bear minimum qualifications, but they do not require you to own a building worth millions of dollars to take advantage of the tax deduction. Property with a base qualifying amount of $1,000,000 and new building additions as low as $500,000 comply.
2. Fiction: A cost segregation study’s cost outweighs the return on investment
Fact: The expense to conduct an analysis depends on the size of the property…but so does the tax savings. Yes, the larger the building, the more the study can cost.
But a larger facility also grants more tax savings opportunities as well. So a careful, expert analysis of your property assets and improvements could yield substantial savings and increased cash flow.
3. Fiction: There’s no reason to do the study when I will eventually receive the deductions anyway
Fact: A typical commercial building holds a depreciable life of 39 years, a residential holds 27.5 years. But cost segregation can cut certain portions down to 5, 7, or 15 years.
The tax deduction you receive today will be worth more than in the future, and you have the opportunity to invest that money immediately back into your business. Why wait 39 years when you can increase your cash flow in as little as 5?
4. Fiction: I fear an audit and cost segregation seems too risky
Fact: Cost segregation is a legitimate tax deduction. You only put yourself at risk by submitting false or inaccurate information. To avoid IRS penalties, take every measure to ensure all your data and forms are authentic and reconciled.
One of the best ways to accomplish this is to enlist the aid of a tax specialist. An expert cost segregation consultant knows the intricacies of the landscape and can help you sidestep potential pitfalls. The IRS doesn’t accept lack of knowledge as an excuse for misinformation or incorrect documents.
5. Fiction: When I sell the property, the depreciation recapture tax will force me to pay back what money I saved through cost segregation
Fact: The depreciation recapture tax permits the IRS to collect income tax on a gain realized when a taxpayer disposes of an asset that afforded an offset of ordinary income through depreciation.
"Cost segregation depreciation offsets “ordinary income currently taxed at 12 to 37 percent; whereas, the recapture, upon sale, is taxed as 15 to 20 percent capital gains rate. The portion of the gain equal to the depreciation would be subject to the 25 percent recapture rate, which is still lower than the rates for most individuals. There’s typically a 10 to 20 percent total arbitrage between the two.
“Offset ordinary income today with depreciation, and you repay it at either a capital gain or 25 percent rate, both of which are probably lower than the rate would otherwise be.” 1
This is still contingent upon how long the owner held the property before selling. Determining whether cost segregation works in your favor should be handled on a case-by-case basis, preferably with the aid of a qualified CPA.
“Under the time value of money, you get the use of the tax savings today and don’t have to repay it until the future sale date.”1
The Truth Comes Out
Cost segregation stands as a complicated deduction compromised of many rules and requirements. All these intricacies can lead to misconceptions and misinformation. To help sort out the truths that lead to accurate claims and maximum tax savings, call upon a tax specialist.
1. Debunking the Myths of Cost Segregation, Accounting Today, 2018