Real estate is one of the only U.S. investments that can be depreciated for tax savings as long as property owners understand and utilize cost segregation to maximize their cost recovery. Whether newly constructed, purchased or renovated, portions of a building can be classified into shorter recovery periods for quicker depreciation. The Tax Cuts and Jobs Act (TCJA) of 2017 included provisions that greatly enhanced the benefits of cost segregation studies.
What is Cost Segregation?
The IRS allows the separation of building components so that items such as land improvements and personal property can be separately depreciated over shorter recovery periods for cost savings. The process of identifying assets and determining which costs qualify for accelerated depreciation is a critical tax-savings tool for commercial property owners.
As a property investor, let's say you installed new flooring throughout your building. Every year, you can write that flooring off on your taxes until the end of its useful life. That period of time that the asset depreciates is considered the recovery period and the shorter the recovery period, the greater the reduction in tax liability. Typically, a building will yield 25-35% of the total costs that can be segregated into land improvements and personal property.
A property’s structure is generally subject to a 39-year recovery period for nonresidential periods and 27.5-year for residential, while land improvements qualify for a 15-year recovery period and personal property qualifies for a five-year recovery period. However, cost segregation may now allow affected assets to be depreciated on a five-, seven- or 15-year schedule.
How Did 2017 Tax Reform Enhance the Benefits of Cost Segregation?
Bonus depreciation was established as a stimulus measure in 2001. Its purpose was to allow taxpayers to deduct a certain percentage of their asset costs in the first year they are placed in service. Courtesy of the tax reform package, property owners and investors can benefit from two changes to bonus depreciation. First, used property is eligible for bonus depreciation for the first time. Second, the bonus depreciation percentage was increased to 100% for assets acquired after Sept. 27, 2017, through tax year 2022. Before tax reform, only new property qualified, and bonus depreciation was set to be 50% in 2019.
What is a Cost Segregation Study?
To take full advantage of these changes, residential and commercial property owners can significantly improve their tax position and near-term cash flow with a cost segregation study. Under the guidance of engineering and tax professionals, this federal income tax tool will identify real property assets and which portion of those costs can be treated as real property for accelerated depreciation. In other words, a taxpayer can shift certain assets from being depreciated at 27.5 years (residential) or 39 years (commercial) and potentially reclassify them as five-year or seven-year (personal) or 15-year (land improvements.) By segregating personal property from a building, some costs can be depreciated at a much faster pace.
The new tax law offers great cost-savings opportunities for those owners and investors who utilize a cost segregation study to identify all qualifying assets.
The engineering and tax professionals on the cost segregation team at Engineered Tax Services have helped real estate owners and investors significantly increase their cash flow by identifying and reclassifying assets of their building for faster depreciation. Request a Free Benefit Analysis to identify an estimated benefit and ensure a cost segregation study makes sense for your property.
To learn more about cost segregation studies for real estate owners and investors, call Engineered Tax Services at (800) 236-6519 or visit our cost segregation services page for more information.