The 1031 Exchange Institute

Welcome to The 1031 Exchange Institute™. The 1031 Exchange Institute is your complete online resource for 1031 exchange, 1033 exchange, 1034 exchange, 721 exchange, 453 installment sale and 121 exclusion information.  Information will also be provided regarding Self-Directed IRAs, including Traditional IRAs, ROTH IRAs, SEP-IRAs and SIMPLE IRAs. 

The 1031 Exchange Institute is dedicated to educating and informing real estate investors and their advisors on the benefits of 1031 tax-deferred exchanges and other tax deferred and tax exlcusion strategies so they can make better informed investment decisions.

What are the Tax Benefits of Cost Segregation Analysis?

Reducing your taxes and deferring your taxes are the two (2) primary income tax benefits of obtaining a cost segregation analysis or study on your real estate.  Reducing income taxes occurs since more of your taxable income is taxed at your capital gain tax rate instead of your ordinary income tax rate.  Deferring your taxes occurs since depreciation is more accurately and precisely written off in the early years of your real property ownership.

Reducing your taxes is the most meaningful, but the least understood, income tax benefit of performing a cost segregation analysis.  Consider the following example of how performing a cost segregation study can convert your income that would be taxed at 35% to income that is taxed at 15%:

Barbara is a doctor who earns $350,000 per year.  Barbara acquires a hospital facility in January 2004 and sold it in December 2005.  Barbara's cost segregation study increased the amount of her depreciation expense by $80,000 in both 2004 and 2005.  The higher level of depreciation expense decreased Barbara's taxable income by $28,000 in both 2004 and 2005, for a total reduction of $56,000 (based on ordinary income tax rates).  However, Barbara's capital gains will increase by $160,000 in 2005, based on two years of additional depreciation ($80,000 per year X 2).  The additional capital gains tax will be $24,000 ($160,000 X 15% capital gains rate). Hence, Barbara's net taxable ordinary income sees a tax reduction of $32,000 ($56,000 - $24,000) over just a two (2) year period. This analysis does not consider the time value of money.

In addition to providing lower income taxes due to the quickly depreciation schedules, cost segregation analysis can also benefit businesses in a number of other ways:

  1. Maximizing tax savings by adjusting the timing of deductions. When an asset’s life is shortened, depreciation expense is accelerated and tax payments are decreased during the early stages of a property’s life. This, in turn, releases cash for investment opportunities or current operating needs.
  2. Creating an audit trail. Improper documentation of cost and asset classifications can lead to an unfavorable audit adjustment. A properly documented cost segregation helps resolve IRS inquiries at the earliest stages.
  3. Playing Catch-Up: Retroactivity. Since 1996, taxpayers can capture immediate retroactive savings on property added since 1987. Previous rules, which provided a four-year catch-up period for retroactive savings, have been amended to allow taxpayers to take the entire amount of the adjustment in the year the cost segregation is completed. This opportunity to recapture unrecognized depreciation in one year presents an opportunity to perform retroactive cost segregation analyses on older properties to increase cash flow in the current year.
  4. Additional tax benefits. Cost segregation can also reveal opportunities to reduce real estate tax liabilities and identify certain sales and use tax savings opportunities.