Often, businesses allocate all or most of their buildings’ acquisition or construction costs to real property, overlooking opportunities to allocate costs to shorter-lived personal property or land improvements.
A cost segregation study might allow you to accelerate depreciation deductions, reducing taxes and boosting cash flow.
And under current law, the benefits of a cost segregation study are greater now than they were a few years ago due to depreciation changes (i.e. bonus and qualified leasehold improvement depreciation).
Primer in Depreciation
Business buildings have a 39-year depreciation period (27.5 years for residential rental properties). A building’s structural components, including walls, windows, HVAC systems, elevators, plumbing, and wiring, are depreciated using the same period as the building. Personal property — such as equipment, machinery, furniture, and fixtures — is eligible for accelerated depreciation, usually over five or seven years. Land improvements, such as fences, outdoor lighting, and parking lots, are depreciable over 15 years.
In some cases — computers or furniture, for example — the distinction between building and personal property is obvious. But the line between the two is frequently less clear. Items not permanently attached may be personal property. For example, removable wall and floor coverings, removable partitions, awnings and canopies, window treatments, signs, and decorative lighting.
Items that generally would be considered a structural component may be eligible for accelerated deductions. This occurs when the component serves more of a business than a structural function. Examples include reinforced flooring to support heavy manufacturing equipment, the electrical or plumbing installations required to operate the equipment or dedicated cooling systems for data processing rooms.
Segregate property into the proper tax life
A cost segregation study combines engineering and accounting techniques to identify building costs that are properly allocable to the tangible personal property rather than real property. The Tax Cuts and Jobs Act (TCJA) enhanced certain depreciation-related tax breaks applicable to personal property. The act permanently increased limits on Section 179 expensing, which allows immediate expensing of the entire cost of qualifying property. The definition of 15-year-property treated as qualified improvements was expanded, and it temporarily increased first-year bonus depreciation to 100% from 50%.
Tax savings can be bountiful
Fortunately, it isn’t too late to get the benefit of accelerated depreciation for items that were incorrectly assumed to be part of your building for depreciation purposes. The procedures to “fix” past years’ misclassifications are easier than you think. You don’t have to amend your past returns; instead, you can claim additional depreciation expense by following the automatic IRS change procedures with a Form 3115 that is filed with the next tax return that you file.
Cost segregation studies can provide substantial benefits and cash flow, but they’re not right for every business—an office or apartment building would typically have more short-life property than a warehouse. Also, beware that some states do not follow the enhanced federal depreciation rules. For example, Wisconsin does not allow bonus depreciation but does conform with the expanded 179 expensing. Please contact a tax specialist at Wegner CPAs; we can assist in determining if a study makes sense for your business/property.