How To Do A Cost Segregation Study
To maximize depreciation on your property, you must perform a cost segregation study. Learn about the two ways to complete a cost segregation study to boost your depreciation deductions.
To take advantage of tax benefits on your commercial or investment property, you first have to learn how to do a cost segregation study. In this post, we’ll look at how to perform a cost segregation study, cost segregation approaches, and more so you can maximize depreciation on your federal tax return.
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Hire A Cost Segregation Company To Perform A Study
The easiest and most accurate way to do a cost segregation study is by hiring a cost segregation company. Your cost segregation team should include CPAs, engineers, and other experts.
The cost of hiring a cost segregation company is pretty steep so you want to make sure you select the right company. While most companies offer a free feasibility analysis to provide you with an estimate, expect to pay around $5,000 to $15,000 if you choose to move forward with the study. When doing your research, know what to look for in a cost segregation company, including experience, case studies for previous clients, positive customer reviews, and competitive pricing.
While you should ideally hire a cost segregation company directly after acquiring, building, or remodeling a property, cost segregation companies can perform look-back studies for assets that were acquired in prior tax years. In other words, it’s not too late to take advantage of depreciation deductions if you’ve waited for a cost seg study.
Check out our free cost seg calculator to see how much you could save.
What To Expect During A Cost Segregation Study
There are four steps to complete a cost segregation study. Once you’ve selected a cost segregation company, here’s what to expect:
- Feasibility Analysis: A basic analysis of your tax position and the property will determine if cost segregation is beneficial. An estimate can be provided to give you an idea of your potential tax benefits.
- Documentation Collection: Documentation about your property and assets will be collected by your team.
- Property Analysis: A full analysis of the property is conducted.
- Cost Segregation Report: A full report with study results, methodology, a breakdown of assets, and other information will be provided to you.
The cost segregation study should take around 60 days to complete, although this timeline varies based on factors including your tax situation, the size/type of your property, etc.
Can You Do A Cost Segregation Study Yourself?
It is possible to do a cost segregation study yourself; however, we don’t recommend going this route. The expense of hiring a team of professionals may be intimidating, but these experts have the knowledge to complete the study in a timely manner, all while ensuring that calculations are accurate.
If you opt to complete the study yourself, you take the risk of errors and omissions on your federal tax return that could result in costly penalties and interest from the IRS.
Additionally, the process is time-consuming and extremely complex. Just to give you an idea of how complex, the IRS Cost Segregation Audit Technique Guide is over 260 pages. If you’re not well-versed in tax law, this information can be difficult to understand and apply.
If you do decide to go the DIY route, consider investing in cost segregation software.
Cost Segregation Software
Cost segregation software is used by CPAs or property owners to simplify the cost segregation process. Features may include calculations, depreciation adjustments, and even audit support from financial experts.
While cost seg software can make the process easier, it isn’t foolproof. Additionally, your unique tax situation, property type, and other factors may not be a good fit for using DIY software.
Some examples of cost segregation software include KBKG’s Residential Cost Segregator, DIY Cost Segregation, and Cost Seg EZ. While these options aren’t free, they’re significantly cheaper than hiring a team of cost segregation experts.
Cost Segregation Study Approaches
There are numerous approaches to cost segregation studies. Whether you hire a team of experts (which we recommend) or tackle the task yourself, a specific approach will need to be taken to improve the accuracy of cost seg calculations.
The IRS Cost Segregation Audit Technique Guide details six of the most common approaches, although it is worth noting that there are other approaches outside of these listed.
How To Report Cost Segregation On Your Tax Return
To report cost segregation on your tax return, you’ll need to complete and submit IRS Form 3115, Application for Change in Accounting Method. Information found on your study’s Cost Summary and Cost Detail page needs to be reported on IRS Form 4562, Depreciation and Amortization. The calculations will then need to be carried over to the appropriate form for your tax return.
For properties that were owned and put into service prior to the current tax year, you’ll need to submit Form 3115 to the IRS. You do not have to file an amended return. You’ll need to calculate catch-up depreciation for prior years and record this information on the form.
This step can be complicated, and it’s easy to make an error that can result in penalties and interest from the IRS. To simplify the process and alleviate stress, we recommend working with a CPA or tax preparer or investing in tax software. Or you can learn more about how to report cost segregation on your tax return if you prefer the DIY route.
Next Steps For Starting Your Cost Segregation Study
If you own a commercial or investment property, don’t put off doing a cost segregation study, as you can save thousands of dollars by using this tax strategy.
Start doing your research now to pick the best cost segregation company to perform your study. Don’t hesitate to ask questions and compare options to find the right company for your tax situation. If you already work with a CPA or tax professional, inquire about cost segregation studies and ask for referrals.
If you do opt to go the DIY route, make sure to do your research. The Internal Revenue Service has an abundance of resources at your disposal, although most taxpayers will find that hiring a team of experts is more than worth the initial upfront cost.