From an architectural perspective, a building can be classified not merely as a single structure but rather as an amalgamation of thousands of different components, which all comprise various lifespans and functions. A cost segregation study can identify these individual components and extract them from the traditional 39-year commercial or 27.5 year residential depreciation schedules into significantly reduced 5, 7 or 15-year schedules, drastically improving cash flow.
Within the commercial development sector, the life of a building tends to be measured against its structural integrity or aesthetic relevance, but building owners know that the tax life is equally as vital. Architects and designers are responsible for deciding whether a client’s capital will be locked into a 39-year straight-line depreciation trap or separated through strategic building components depreciation.
Companies like R.E. Cost Seg have become an invaluable resource and partner for those looking to implement an effective commercial property tax strategy that enables them to move beyond being just another service provider. Cost segregations services will help you turn a well-documented set of drawings into a tax-saving financial tool.
How Accelerated Depreciation Works
The IRS doesn’t see a building as a single asset but, rather, a stack of components. While the core components of the structure, like the foundation, roof and framing, are depreciated over the course of 39 years, many of the systems you design can be reclassified into 5, 7, or 15 year reovery periods. This reclassification forms the basis of cost segregation services and, as the designer of the built environment, your specifications are what will dictate those classifications.
The Interior Systems
Most of what you would typically regard as interior architecture or personal property would fall into the 5 and 7-year depreciation schedules. These are normally the items that aren’t really essential components of the building’s primary function as a shelter.
It includes things like:
- MEP and lighting like decorative sconces, track lighting for accenting, and the dedicated electrical circuitry required for kitchen appliances.
- Flooring and finishes in the form of carpeting, vinyl and even certain types of wooden flooring.
- Tenant improvements depreciation is a rather lucrative area that includes removable partitions, specialty millwork and some forms of plumbing.
The Exterior Environment
Everything outside the box will typically fall under land improvements and be eligible for the 15-year depreciation schedule.
It can include:
- Parking lots
- Softscapes
- Infrastructure
As an architect or site planner, your sitework designs are prime candidates for this reclassification category.
Why Documentation is The Ultimate Audit Trail
A real estate cost segregation study is an engineering-based analysis that requires an intricate breakdown of the costs that tax professionals wouldn’t be able to provide without your help. This is why architectural documentation is an integral component of any effective commercial property tax strategy.
While performing a study, an engineer will identify eligible areas for take-offs by analyzing:
- Construction drawings
- Specifications
- Material schedules
By providing high-quality documentation, you’re essentially building your client’s defense against an IRS audit.
Blueprints and Elevations
Your blueprints and elevations will be used to distinguish between a load-bearing masonry wall that depreciates over 39 years and a non-load-bearing accent wall that depreciates over 5 years.
Electrical and Plumbing Risers
Keeping detailed MEP drawings can also help make the distinction between dedicated lines and general lines clearer, which can potentially save a client hundreds of thousands of dollars in the first year of ownership.
BIM and Digital Twins
If you’re using Building Information Modelling (BIM), you can furnish your client with data fueled system where every component, down to the specific lighting fixture or flooring type, is tagged and quantified. This level of precision is the bedrock upon which cost segregation rests.
Capital Improvements vs Repairs
Many homeowners struggle to differentiate between capital improvements and repairs, a distinction that typically occurs during the renovation phase. When designing a renovation, you probably add new components in addition to removing the old ones.
By maintaining a detailed history of the building’s components, you can help the owner take advantage of Partial Asset Disposition (PAD).
If you replace a 20-year-old HVAC system that you originally specified, the owner can write off the remaining undepreciated value of the old system in the year of removal.
However, owners often lose that value without the original specifications and updated design documentation.
Giving Yourself a Competitive Edge
Architects are usually the first point of contact for developers when they’re considering a new project or major renovation. By mentioning the benefits of a cost segregation study early on, you can immediately add tangible value to the partnership.
Despite not working anywhere within the financial tax sector, understanding the relationship between building components and accelerated depreciation can guide architects in optimizing their designs and packaging data. In an era where every basis point of return matters, an architect who understands the tax life of their building is the architect who will win the client for life.