Preface: A cost segregation study identifies and reclassifies personal property assets to accelerate the depreciation expense benefit for taxation purposes, reducing current income tax costs. The primary goal of a cost segregation study is to identify all construction-related costs that can be depreciated over a shorter tax life (typically 5, 7 and 15 years) than say the 39 years for non-residential real property.
Tax Benefits of A Cost Segregation Study
Business and individual taxpayers that build or acquire nonresidential real property, e.g. warehouses, manufacturing space or residential rental property, e.g. rental unit(s) have an opportunity to reap tax benefits with a reduction of the depreciable calendar period recovery on the assets which are qualifying building components. Certain assets may qualify for shorter depreciable lives and recovery periods under MACRS depreciation. The reduction of the qualify building component asset lives provides accelerated deductions to offset income under the current Tax Cuts and Jobs Acts tax regime.
Many taxpersons have mistakenly included the costs of such qualifying components in the depreciable basis of the building and the tax benefits and cost are therefore recovered over a longer depreciation period. A nonresidential real property is depreciated over a 39-year life and a residential rental property is depreciated over 27.5-years. Certain building components may qualify for a reduced recovery period over 5-years, 7-years, or 15-years.
Some examples of building components include: parking lots, sidewalks, curbs, roads, fences, storm water management, landscaping, signage, lighting, security and fire protection systems, removable partitions, removable carpeting and wall tiling, furniture, counters, appliances and machinery (including machinery foundations) unrelated to the operation and maintenance of the building, and the portion of electrical wiring and plumbing properly allocable to machinery and equipment that is unrelated to the operation and maintenance of the building.
A taxperson may engage a CPA specialist to conduct a cost segregation study to identify the separately depreciable components and their depreciable basis. Ideally, a cost segregation study should be conducted prior to the time that a building is placed into service (i.e., when it is under construction or at the time of purchase). However, a cost segregation study can be completed after a building is placed in service. Even if a detailed cost segregation study is impractical, a practitioner should carefully consider whether there are any obvious land improvements and personal property components of a building that can be separately depreciated over a shorter recovery life.
After the fact? The change(s) to the depreciation lives require either an amended return or an accounting method change (if two years after the property is acquired or placed in service). The reporting to the IRS includes the change of basis, depreciable lives, and any adjustments for the impact of the depreciation acceleration from the date placed in service to the year of the method change. Certain restrictions apply in certain instances, and you are advised to consult with a tax advisor on the possible tax benefits before beginning a cost segregation study for your real estate holding(s). This includes factoring the holding period of the real estate and management of possible depreciation recapture costs.
If you have built or acquired a nonresidential real property, e.g. warehouses, manufacturing space or residential rental property, e.g. rental unit(s) recently, please discuss the benefits of a cost segregation study with your tax advisor to obtain maximized tax benefits.