HOW ARE COST SEGREGATION RESULTS APPLIED TO YOUR TAX RETURN?

So you had a cost segregation study done – now what?  Well, the answer depends on whether your study covers a property that is already depreciating or a newly acquired property.  Let’s look at both scenarios: 

1. To apply cost segregation results to a tax return with existing properties, taxpayers need to file IRS Form 3115, Application for Change in Accounting Method, along with their tax return for the tax year where you want to apply the “catch-up” depreciation expense. This Form 3115 allows taxpayers to change their method of accounting for depreciation from straight-line to accelerated depreciation based on the results of the cost segregation study. The form is used to report the change in method and to calculate the catch-up depreciation that can be claimed in the year the change is made.  The catch-up depreciation is calculated by taking the difference between the depreciation that previously had been claimed under the old method and the depreciation that should have been claimed under the new method for all prior years. This catch-up amount is then added to the depreciation for the current year and claimed on the tax return.  This adjustment is called Section 481(a) adjustment, and it goes on line 26 of Form 3115.  IMPORTANT: This adjustment amount is entered as a NEGATIVE NUMBER.  Your tax preparer or cost segregation specialist will provide this 481(a) adjustment amount based on the results of the study. 

1. If the cost segregation study is for a newly acquired property and it does not require a change in accounting method, the results of the study can still be applied to the tax return for the year the property was acquired. The taxpayer would need to follow the IRS guidelines for reporting the depreciation of the property based on the results of the study.  In this case, the taxpayer would not need to file IRS Form 3115, Application for Change in Accounting Method, since there is no change in the method of accounting for depreciation. Instead, the taxpayer would report the depreciation deductions based on the results of the cost segregation study on their tax return for the year the property was acquired.  Typically, your cost segregation study will break the building down into three asset categories: Asset Class 57.0 – Distributed Trades and Services, otherwise known as 5-year property, Asset Class 00.3 – Land Improvements, otherwise known as 15-year property, and real property depreciating at 27.5 years for residential and 39 year for commercial. 

It's important to work with a qualified tax professional familiar with accounting for real estate and cost segregation to ensure that the cost segregation study is properly applied to the tax return in accordance with IRS guidelines and regulations.

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