Cost Segregation Study

Yes – cost segregation is expressly permitted by IRS rules and is a common tax strategy in the real estate industry. The IRS has published audit guidelines for cost segregation to outline how these studies should be performed. When done properly (with detailed documentation and following the tax code and regulations), cost segregation complies with IRS requirements. It’s not a tax “loophole” or scheme, but rather an established method of depreciation. That said, it’s crucial to have qualified professionals conduct the study. 

A well-documented cost segregation analysis will provide the support needed to withstand IRS scrutiny. Hemlock Financial’s studies are performed in accordance with IRS guidelines and come with full documentation. We stand behind our work and will assist if any questions arise. In short, it’s a legitimate and safe strategy when you follow the rules – and we make sure you do.

Attempting to do it yourself is not recommended. A cost segregation study is a highly specialized analysis requiring engineering knowledge to identify and value building components, as well as tax expertise to apply the correct depreciation classifications. Most CPAs are not trained to break down construction costs at the component level – that’s where our engineering team comes in. In fact, even the IRS expects cost segregation to be done by professionals with “expert knowledge” in engineering and cost estimation. A DIY approach could miss significant tax-saving opportunities or, worse, misclassify assets and risk non-compliance. By using Hemlock Financial’s dedicated cost segregation experts, you ensure the study is thorough and accurate. We do the heavy lifting and then coordinate with your CPA to integrate the results into your tax filings seamlessly. This way, you get the maximum benefit with minimum hassle.

The optimal time is during the same tax year that you acquire, build, or renovate the property. This timing allows you to claim the accelerated depreciation in that first year, right when your investment outlays are highest. However, if you didn’t do a study in the first year, you can still benefit from cost segregation services later through look-back studies. For new construction, it can even be beneficial to consult during the construction phase – certain decisions or cost allocations can maximize future depreciation benefits. In summary: complete your cost segregation analysis as early as feasible, but don’t hesitate to pursue it on older properties too, since the law allows retroactive adjustments.

Simply having a cost segregation study done does not, by itself, trigger an audit. It’s a fairly common practice, especially for larger properties, and the IRS is familiar with it. The key is making sure the study is done correctly by qualified professionals. A properly conducted cost segregation analysis will withstand an audit, not cause one. The potential consideration to be aware of is depreciation recapture if you sell the property. Accelerating depreciation now means you have a lower remaining basis later; when you sell, the IRS may tax the portion of gain that is due to depreciation (recapture) at a certain rate. This doesn’t mean cost segregation is a bad idea – it just means you should plan with your tax advisor for the eventual sale. Often, the time value of money benefits of cost segregation still make it advantageous, or you might employ strategies like 1031 exchanges to defer taxes further. We can help you understand these considerations in the context of your overall investment plan. In general, for long-term holds, the benefits of cost segregation far outweigh the recapture issue, and if you end up holding until the end of life or doing a 1031 exchange, recapture can be mitigated.