Cost Segregation Studies & Accelerated Depreciation

Cost Segregation Dunham Group[This article on Cost Segregation is excerpted from NAI The Dunham Group publication 10th Annual Greater Portland 2021 Industrial Market Survey, found on page 9.]

For any building buyer or owner, cash flow is a critical measure of the financial viability and success of a property. A building’s cash flow can help pay down debt, fund improvements, and generate income. While depreciation is not a “cash” expense, it plays an important role in supporting a building’s cash flow.

A commercial or industrial property depreciates over a period of 39 years. Said another way, a building owner can deduct a portion of the cost of their building (minus the land value) every year over this period, creating a non-cash expense on the income statement. While a building owner can depreciate the same amount each year over 39 years, a cost segregation study can help change this equation and maximize the tax benefits of owning a commercial, industrial, or even a multifamily residential property.

A cost segregation study is the practice of identifying assets and their costs, and classifying those assets into categories for accelerated depreciation. Many of the costs embedded in a new or existing building can be segregated into categories that also allow for more rapid— or accelerated—depreciation. Typical examples of items that can be allocated to the 5 and 7 year lifespan are wall and floor coverings, architectural millwork, electrical and plumbing supply to personal property, decorative lighting, furnishings, signage, and window treatments. In addition, outdoor features such as paving (like a large parking lot!) and landscaping can be depreciated over a 15-year period.

The study documents property asset categories and develops a cost estimate on each item. Owners can use this information to support the accelerated depreciation of expenses in the first few years of a property’s life. This accounting strategy delays taxes, generating extra cash building owners can use to finance fit-up improvements, marketing, or other necessary expenditures.

Cost segregation studies are best suited for:

  • Real estate construction valued at over $1 million
  • Building acquisitions or improvements
  • New buildings under construction
  • Existing buildings undergoing renovations or expansions over $750,000

The best savings potential is with these types of properties:

  • Office buildings and shopping centers
  • Warehouses and distribution centers
  • Manufacturing and industrial plants
  • Medical facilities
  • Restaurants and Breweries
  • Shopping Centers
  • Hotels

For investors considering whether to purchase a property and for real estate brokers trying to make a transaction feasible when the numbers are tight, a cost segregation study may be essential to boosting cash flow in the first years of ownership.

A cost segregation study may be done independently or conducted in parallel with other due diligence such as a building inspection or property condition report. According to the IRS, a cost segregation study by an Engineer is preferred, as it is more reliable than one conducted by someone with no engineering or construction background.

Criterium Engineers has performed thousands of cost segregation studies across the country and can advise a building buyer or owner on the potential benefits for their property.

Nate Powelson, P.E.
Project Engineer, Criterium Engineers