Do you itemize your allowable expenses on your personal tax return instead of taking the standard deduction? If so, why? You probably do it because it lowers your taxes.
It is surprising that so many people who own commercial buildings or multi-family buildings worth over $1 million use the “standard deduction” to depreciate their building. First, it’s important to understand what deprecation does and how it helps you save on taxes. Depreciation is a reduction in the value of an asset due to wear and tear on the building. The standard depreciation method allows you to deduct an equal portion a commercial building value every year for 39 years (27 ½ years for multifamily). So, a building worth $390,000 would result in a depreciation expense of $10,000 against your income every year for 39 years.
The way to take the “itemized” approach to depreciating your building is to perform a cost segregation study on your building. This study documents each type of material used to construct your building and maps these materials to IRS Publication 946. This 114-page IRS publication details how you can deprecate property, and lower your taxes. A wide range of building components such as electrical installations, plumbing, mechanical components, and finishes can be identified and reclassified into shorter-lived asset classes. Some can be depreciated over 15 years, 7 years or even 5 years. The different construction materials used in your building have different useful lives. For example, Carpet is not going to last as long as the foundation, so carpet can be depreciated much faster than the foundation.
The accelerated depreciation schedule will result in much higher tax savings in early years than with the 39-year depreciation schedule. In later years, the depreciation will be lower. Most people recognize the time value of money in that larger deductions now are worth more than lower deductions spread equally over a longer period. You can use the tax savings from the accelerated depreciation to re-invest in your business or increase your income.
It is important to engage an expert in cost segregation studies because they must have knowledge of both the construction process and the tax laws. A quality cost segregation study and detailed analysis are invaluable in the event of an IRS audit.
Cost segregation studies are one of the most valuable tax strategies available to owners of commercial real estate today. This increasingly popular tax strategy offers building owners the opportunity to defer taxes, reduce their overall current tax burden, and free up capital by improving their current cash flow. Virtually every taxpayer who owns, constructs, renovates, or acquires a commercial real estate structure stands to benefit from a cost segregation study.