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Component Depreciation is Not the Same As Cost Segregation is not the same as Tax Reduction - O'Connor & Associates

Component Depreciation (Component Depreciation is not the same as Cost Segregation)

Component depreciation was used widely in the 1970s and early 1980s, but was terminated by tax law changes in 1986. Tax reductions through cost segregation have similar results as tax reductions through component depreciation, but the methodology is different.

Component depreciation focused on separating the systems of a building. These would include items such as the roof, electrical, plumbing and elevators. These components depreciated over a smaller number of years. Hence, depreciating the components individually yielded substantially higher levels of real estate depreciation compared to depreciating the building as a whole. Rightly or not, there were perceptions that component depreciation has been used in an abusive manner. Part of the Reagan tax changes in the mid-1980s ended the use of component depreciation.  As component depreciation was terminated, there was no clearly legitimate method to increase real estate depreciation for about ten years.

Hospital Corporation of America is the landmark case that defined the general boundaries of cost segregation, another form of increasing depreciation. Cost segregation focuses on land and interior improvements, which nearly have a shorter depreciation period and/or economic life. Component depreciation had focused on building systems.

Land improvements, which can be segregated, include items such as paving, curbs, sidewalks, signs and landscaping. Interior improvements that are eligible for short life depreciation include carpet, vinyl tile, signs, wall coverings and certain electrical and plumbing equipment.

The IRS has developed a manual to guide its auditors, appraisers and tax practitioners regarding the theory and application of cost segregation, the Audit Technique Guide (ATG). The ATG clearly defines which items qualify for five, seven and 15-year depreciation lives. Using the IRS guided method in the ATG provides a safe harbor for taxpayers.

A well-prepared cost segregation report will delineate 35 to 100 items which qualify for short-life depreciation. Each of these items increases tax deductions. Conversely, a component depreciation analysis might have only identified five to 10 systems. The IRS and ATG require a qualified specialist to prepare a cost segregation study contemporaneously with establishing the depreciation schedule. This can be done when the property is initially acquired or years later if the real estate owner wants to recast the depreciation schedule and “catch-up” under-reported depreciation.

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Cost segregation is the contemporaneous version of component depreciation. It produces tax deductions and reduces federal income taxes across the country and in every size market. Below are just a few examples of where cost segregation generates meaningful tax deductions.

City:
  • Phoenix, AZ
  • Atlanta, GA
  • Washington, DC
  • Denver, CO
  • Los Angeles, CA
  • Dallas/Ft. Worth, TX
  • Las Vegas, NV
  • Baltimore, MD
  • Miami, FL
  • Philadelphia, PA
  • Oxnard, CA
  • Oklahoma City, OK
  • Columbus, OH
  • McAllen, TX
  • Jacksonville, TN
  • Salt Lake City, UT
  • Tucson, AZ
  • Omaha, NE
  • Dayton, OH
  • Nashville, TN
  • Rochester, NY
  • Charleston, SC
  • St. Louis, MO
  • Columbia, SC
  • Milwaukee, WI
  • Stockton, CA
  • San Diego, CA
  • Akron, OH
  • Austin, TX
  • Bakersfield, CA
Cost segregation produces tax deductions for virtually all property types.

Property Type:
  • Nursing home
  • Shopping center
  • Daycare center
  • Discount store
  • Used car lot
  • Bar
  • Cold storage facility
  • Shopping mall
  • Skating rink
  • School
Almost every industry, including the following, can generate cost-efficient tax deductions by using cost segregation.

Industry:
  • Textile product mills
  • Textile mills
  • Furniture manufacturing
  • Machinery manufacturing
  • Warehousing and storage
  • Plastic and rubber products manufacturing
  • Paper manufacturing
  • Truck transportation
  • Real estate lesser
  • Apparel manufacturing



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