When a building asset hits your books as a fixed asset, whether due to purchase, construction, or renovation, the straight-line depreciation method tells us to plop it in one of two bins, 39-year properties or 27.5-year properties, and await your taxable income deductions for each year of the recovery period. By redefining the recovery period “bins” a bit, however, you can reap additional benefits, including higher income tax deductions, deferred income tax, and increased cash flow.
While the lump-sum cost of a property is easily discerned, the cost by individual component can be a bit trickier. That property cost is likely the total of several areas of cost, including things like land, land improvements, buildings, furniture & fixtures, and equipment, each with its own recovery period. So, how do you redefine and reclassify assets to take advantage of these additional benefits, and how do you know which assets qualify? Obtain Cost Segregation Studies.
A Cost Segregation Study is a formal assessment performed by accountants and engineers to identify and reclassify personal property assets to shorten depreciation time for income tax purposes. These studies are performed by industry-specialized, independent third-parties and result in a formal report which can be used in IRS audits, when documentation is necessary. The TCJA legislation in 2017 broadened the requirements for an asset to qualify for accelerated depreciation methods, such as Bonus Depreciation and Section 179 Expensing. Since this change, Cost Segregation Studies have become an increasingly valuable tool. These studies are an excellent addition to your overall tax strategy.
Cost Segregation Study Process
The process varies from project to project, but, in general, a Cost Segregation Study will likely encompass interviews with property managers, visits to and inspections of the property itself, and a review of things like blueprints, appraisals, and cost details. Estimates may be used when certain items aren’t available for review. Expertise is key, however, as specific characteristics and uses are needed for each asset associated with a project to qualify for a shorter depreciable life; for example, you may have a qualifying fixture in one room and an identical fixture in a separate room that perhaps does not qualify based on its placement and use.
Reclassifying an asset from a 39-year life into multiple components with 3, 5, 7, or 15-year lives, for example, accelerates depreciation deductions. With the TCJA legislation, cost segregation opportunities have increased, as more assets now qualify for Bonus Depreciation or Section 179 Expensing.
Bonus Depreciation – Bonus Depreciation is applied by class life. All property with a class life no more than 20 years qualifies, and there is no limitation or cap. It can, however, create a loss. Contrary to the previous 50% Bonus Depreciation rule, current tax law following the TCJA allows for 100% Bonus Depreciation for property placed into service after September 27, 2017, through 2022. And the allowable percentage of Bonus Depreciation is 80% for 2023, 60% for 2024, 40% for 2025, and 20% for 2026.
Section 179 Expensing – Section 179 is best for immediate expensing, can’t create a loss, and does not apply to the entire class life. And, until we receive the highly anticipated technical correction from lawmakers, it’s the sole alternative for deducting Qualified Improvement Property (QIP). The TCJA broadened the definition of qualified, non-residential real property to include QIP, and now includes things like roofing, HVAC, and fire and security systems. When calculating deductibility, Section 179 allows you to apply shareholder wages as income. The 2019 deduction limit is $1,020,000 for new and used property, and the 2019 spending cap on purchases is $2,550,000, and it’s fully phased out at $3,550,000.
Cost Segregation Studies result in a formal report on findings that is designed to assist your company in implementing accelerated depreciation methods that maximize your income and minimize your tax liability. Since, in the eyes of the IRS, qualification by asset or component is ultimately your responsibility as the taxpayer, a solid Cost Segregation Report from a knowledgeable service provider is essential in the event of an audit. Your report is a professional opinion outlining and standing behind your chosen depreciation acceleration methods.
The tax benefits vary by business, by project, and by individual assets within. Savings depend on several things like purchase price, purchase date, the use of the building or asset, and the construction method used, to name a few. The savings, however, are significant. For example, our firm has completed projects where the present value of the tax benefits of a project are in the high six-figures. These tax savings can also be beneficial when analyzing the financial validity of taking on a project. Additionally, keep in mind that these potential savings may not be limited to the current year. A change of accounting method may allow you to claim depreciation deductions for prior years as well. Doing a cost segregation study will also enable you to write-off assets that haven’t been fully depreciated that get replaced by doing an asset disposition study.
ARB’s Construction and Real Estate Services Group specializes in tax, accounting, and operational needs unique to your industry. We provide services and partner with Professional Services Firms, including engineering firms, and can confidently meet your fixed asset depreciation, asset disposition, and cost segregation needs. We provide direct services for limited-scope studies, and we work with trusted third-party providers for larger scale studies. As Members of Crowe Global’s CPAmerica, ARB is able to provide local, convenient service with savvy, international knowledge and resources on our side. For more information on Cost Segregation Studies, or any other tax and accounting needs, contact us today.
by David V. Jean, Principal, CPA, CCIFP, CExP