The COVID-19 pandemic has resulted in many companies conserving cash and not buying much equipment during the past year. An unintended downside is that you may not be able to claim the same amount of depreciation tax deductions as you have in past years.
What can you do? A cost segregation study may allow you to accelerate depreciation deductions on certain items, thereby reducing taxes and boosting cash flow. And, thanks to the Tax Cuts and Jobs Act, the potential benefits of a cost segregation study are now even greater than they were a few years ago because of enhancements to certain depreciation-related tax breaks.
Business buildings generally have a 39-year depreciation period (27½ years for residential rental properties). Typically, companies depreciate a building's structural components — including walls, windows, HVAC systems, plumbing and wiring — along with the building. Personal property (such as equipment, machinery, furniture and fixtures) is eligible for accelerated depreciation, usually over five or seven years. And land improvements, such as fences, outdoor lighting and parking lots, are depreciable over 15 years.
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. Items that appear to be "part of a building" may in fact be personal property.
- Removable wall and floor coverings;
- Removable partitions;
- Awnings and canopies;
- Window treatments;
- Signs; and
- Decorative lighting.
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. Examples include reinforced flooring to support heavy manufacturing equipment, electrical or plumbing installations and dedicated cooling systems for equipment or server rooms.
Under the right circumstances, a cost segregation study can yield substantial tax benefits. A cost segregation study identifies real estate components that are properly treated as personal property depreciable over, say, five or seven years, or land improvements depreciable over 15 years. By allocating a portion of your costs to these shorter-lived assets, you can accelerate depreciation deductions and substantially reduce your tax bill. And, do not overlook bonus depreciation. If these assets qualify, the tax savings can be even greater.
Bear in mind that tax law changes may occur this year that could affect current depreciation and expensing rules. This in turn could alter the outcome and importance of a cost segregation study.
Conducting the study
A cost segregation study should be performed by an outside, independent firm. According to the IRS Cost Segregation Audit Techniques Guide, there are no prescribed qualifications for cost segregation preparers. The guide, however, states that a study conducted by a construction engineer would, all else being equal, be considered more reliable than one by someone without a construction background.
The guide further states that other important criteria include "experience in cost estimating and allocation, as well as knowledge of the applicable law." It adds: "A quality study identifies the preparer and always references their credentials, experience and expertise in the cost segregation area."
Rewarding tax benefits
Though the relative costs and benefits of a cost segregation study will depend on your particular facts and circumstances, it can be a valuable investment. Cost segregation studies have costs all their own, but the potential long-term tax benefits may make it worth your while to undertake the process. Contact your ORBA CPA for further details.
Originally Published by Ostrow, March 2021
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.