In the United States, the tax code is a meandering list of thousands upon thousands of words. Hidden in this code are all of the tax laws and loopholes businesses and people take advantage of every year to pay as little tax as possible.
One of these is known as cost segregation. This is a way of identifying assets that should be depreciated or taxed at a different, often lower, rate than other items.
For tax purposes, a cost segregation study reclassifies assets to reduce the depreciation time for tax purposes. This has the benefit of reducing tax liabilities and increasing cash flow.
For example, a house used for business purposes can be depreciated over 39 years. While certain appliances within the house, such as a refrigerator, washer, dryer, etc, could be depreciated for five or even seven years.
In a business tax sense, depreciating assets allows a business to purchase new equipment, but get some tax benefits from it. Let’s say a business buys a truck solely for use by the business. Every year for several years, the business can deduct from its taxable income a percentage of the purchase price of that truck until it is fully depreciated. The business can still continue using that asset and any components.
In our house example, the house fully depreciates over 39 years. While it takes a long time to depreciate, other items can be depreciated faster, such as the aformentioned appliances.
In some instances, up to 50% of an item’s value could be depreciated the first year of the item’s use. The rest would be claimed in subsequent years. Due to the Tax Cuts and Jobs Act, some assets may be depreciable for up to 100% of its value the first year it is placed into service.
Cost segregation also allows a company to claim “lost” depreciation that was not claimed in a previous year without having to file an amended return.
This has the benefit of saving the company money and allows them to have a reduced tax bill. The business may also be shown to be operating at a loss and not have to pay any taxes at all that year.
What is a depreciation study?
Real property that can be eligible for cost segregation includes buildings that have been purchased, remodeled, or constructed since 1987. An engineering study is typically done on the building.
The study tends to find “soft costs” – those paid to contractors, and other costs that could potentially be depreciated. Generally these studies look for land improvements that do not affect the operation or maintenance of a building. These could be sidewalks, driveways, carports, Dumpsters, landscaping, and other things.
Indeed, a company can show a loss on paper, yet due to cost segregation and other depreciation tactics, actually make a large sum of money. So what is a depreciation study? It may save you big money.