Maximizing Tax Benefits with Cost Segregation: Notes for Meeting IRS Guidance

Written by Bill Mark. Updated Aug 7, 2023.


When it comes to commercial real estate investments, one aspect that often goes unnoticed is the potential tax benefit through cost segregation. This powerful tax planning tool allows property owners to accelerate depreciation deductions, resulting in significant savings. In this blog, we will explore the concept of cost segregation, its benefits for companies, and the available guidance provided by the Internal Revenue Service (IRS). We will also delve into why the IRS requires engineers to perform cost segregation studies and its implications for accuracy and compliance.

What is Cost Segregation?

Cost segregation is a process that identifies and reclassifies components of commercial property for tax purposes. Instead of considering the entire property as a single asset, cost segregation breaks it down into various components, such as land improvements, building systems, and personal property. By doing so, property owners can depreciate these components at an accelerated rate, leading to substantial tax savings.

Learn More: Green Building Benefits with 179D

Benefits of Cost Segregation for Companies

  • Enhanced Cash Flow and ROI: By accelerating depreciation deductions, cost segregation allows companies to free up cash flow that can be reinvested into the business. This additional capital can be utilized for various purposes, such as funding expansion initiatives, undertaking renovations or upgrades, or investing in new projects. The improved return on investment (ROI) can contribute to the company’s overall growth and success.
  • Improved Financial Reporting: Cost segregation provides a more accurate and detailed breakdown of property assets, allowing companies to better align their financial reporting with the actual value of individual components. This level of specificity can result in more accurate balance sheets, income statements, and financial statements, which can be particularly valuable for companies seeking financing or attracting investors.
  • Tax Planning and Strategy: Cost segregation is a powerful tax planning tool that enables companies to optimize their tax strategies. By identifying and properly classifying components, companies can maximize depreciation deductions, lower their tax liability, and potentially improve their after-tax profits. This can free up funds for reinvestment, research, and development, or other strategic initiatives.

IRS Guidance on Cost Segregation

The IRS recognizes the validity of cost segregation and provides guidance to ensure compliance with tax regulations. Here are key sources of IRS guidance related to cost segregation:

  • IRS Cost Segregation Audit Techniques Guide: This guide is a comprehensive resource for IRS auditors and provides insights into the principles and methodologies used in cost segregation studies. Property owners can refer to this guide to gain a better understanding of what the IRS considers during audits.
  • Revenue Procedure 2019-09: This revenue procedure establishes safe harbors for cost segregation studies, providing clear guidelines for taxpayers and tax practitioners. It offers a simplified approach to cost segregation and defines qualifying property types and documentation requirements. These regulations provide guidance on capitalization, repair, and maintenance costs for tangible property. They include rules and criteria for determining whether expenses should be capitalized or deducted immediately.

The Role of Engineers in Cost Segregation Studies

The IRS requires engineers to be involved in cost segregation studies to ensure accuracy and compliance. The expertise of engineers is crucial for several reasons:

  • Technical Expertise: Engineers possess the necessary knowledge to identify and evaluate the various components of a commercial property accurately. They can determine the useful lives, salvage values, and depreciation rates for each component, ensuring compliance with IRS regulations.
  • Compliance with IRS Standards: By involving engineers, companies can ensure that their cost segregation studies adhere to specific IRS guidelines and methodologies. This reduces the risk of non-compliance and potential audits.
  • Credibility and Audit Defense: The involvement of engineers adds credibility to the cost segregation study. Their professional and objective perspective strengthens the validity of the study, particularly in the event of an IRS audit. Qualified engineers can provide expert support and defend the depreciation allocations, enhancing the company's position and reducing the risk of IRS challenges.
  • Documentation and Support: Engineers contribute to the cost segregation process by providing detailed documentation, calculations, and support. This documentation substantiates the allocation of costs to specific components, which is essential in meeting IRS requirements and demonstrating compliance.

Final Thoughts

Cost segregation offers a range of benefits for companies, including enhanced cash flow, improved financial reporting, and effective tax planning. By accurately identifying and classifying property components, businesses can optimize their depreciation deductions, reduce tax liabilities, and achieve greater returns on their real estate investments.

To ensure compliance with IRS regulations, it is vital to refer to the available guidance. The IRS Cost Segregation Audit Techniques Guide, Revenue Procedure 2019-09, Revenue Ruling 94-57, and Tangible Property Regulations offer valuable insights and instructions for conducting cost segregation studies. Moreover, the involvement of engineers, as mandated by the IRS, brings technical expertise, credibility, and audit defense to the process.

By harnessing the power of cost segregation and collaborating with qualified professionals, companies can maximize their tax benefits, improve financial outcomes, and make informed strategic decisions. Cost segregation serves as a valuable tool for optimizing commercial real estate investments and achieving long-term financial success.

Contact CTI today and let our team of Cost Segregation experts work to maximize your credit and help you discover your eligibility for this tax deduction.


Research & Development Tax Credit Guide

Topics: Property Incentives, Federal

Bill Mark

Written by Bill Mark

Bill serves as CTI's director of cost segregation for the last four years after previously working as a project manager for Property Incentives for seven years, culminating to more than ten years of tenure with Corporate Tax Incentives. He additionally has over ten years of construction management experience relating to commercial construction as a general contractor. Mark specializes in estimating construction costs and verifying personal versus real property through detailed construction document review or on-site investigations.