Is your business depreciating over a 30-year period the entire cost of constructing the building that houses your operation? If so, you should consider finding a cost segregation specialist for a study. It may allow you to accelerate depreciation deductions on certain items, thereby reducing taxes and boosting cash flow. And under current law, the potential benefits of a cost segregation study are now even greater than they were a few years ago. This positive change is due to enhancements to certain depreciations relating to tax breaks.
Let’s go the basics for depreciation in real estate. Business buildings generally have a 39-year depreciation period (27.5 years for residential rental properties). Most times, you depreciate a building’s structural components. This includes the walls, windows, HVAC systems, elevators, plumbing and wiring, along with the building.
Personal property is eligible for accelerated depreciation, usually over five or seven years. Examples of personal property include equipment, machinery, furniture and fixtures. Land improvements also count in the category of personal property. A few examples include fencing, outdoor lighting and parking lots; all of which are depreciable over 15 years.
Often, businesses allocate all or most of their buildings’ acquisition or construction costs to real property. In turn, they overlook opportunities to allocate costs to shorter-lived personal property or land improvements. In some cases the distinction between real and personal property is obvious. A couple common example include computers or furniture. But the line between the two is frequently less clear. Items that appear to be “part of a building” may in fact be personal property, like removable wall and floor coverings, removable partitions, awnings and canopies, window treatments, signs and decorative lighting. A cost segregation specialist can provide a clear distinction.
In addition, certain items that otherwise would be treated as real property may qualify as personal property if they serve more of a business function than a structural purpose. This includes reinforced flooring to support heavy manufacturing equipment, electrical or plumbing installations required to operate specialized equipment, or dedicated cooling systems for data processing rooms.
A cost segregation specialist can combine accounting and engineering techniques to identify building costs. These costs are properly allocable to tangible personal property rather than real property. Although the relative costs and benefits of a cost segregation study depend on your particular facts and circumstances, it can be a valuable investment.
The Tax Cuts and Jobs Act (TCJA) enhances certain depreciation-related tax breaks. It may also enhance the benefits of a cost segregation study. Among other things, the act permanently increases limits on Section 179 expensing. In turn, this allows you to immediately deduct the entire cost of qualifying equipment or other fixed assets up to specified thresholds.
The TCJA also expanded 15-year-property treatment to apply to qualified improvement property. For real estate depreciation deductions, previous limitations to this break was towards qualifying leasehold-improvement, retail-improvement and restaurant property. And there was a temporary increase on first-year bonus depreciation deduction to 100% (from 50%).
Fortunately, it isn’t too late to get the benefit of speedier depreciation. This applies specifically for items that were incorrectly assumed to be part of your building for depreciation purposes. You don’t have to amend your past returns to claim the depreciation that you could have already claimed. Plus, you don’t have to meet a deadline for claiming tax refunds. Instead, you can claim that depreciation by following procedures, in connection with the next tax return that you file. This will result in “automatic” IRS consent to a change in your accounting for depreciation.
Cost segregation studies can yield substantial benefits, but they’re not right for every business. A cost segregation specialist can judge whether a study will result in overall tax savings greater than the costs of the study itself. To find out whether this would be worthwhile for you, our CPA firm can help.