If your business is depreciating construction costs for your building over a 30-year period, consider a cost segregation study. This resource could help you accelerate depreciation deductions on some items to reduce taxes and boost cash flow. Plus, current laws have boosted the benefits of this study by enhancing depreciation-related tax breaks.
Depreciation fundamentals
Generally, business buildings have a 39-year depreciation period (or 27.5 years for residential rental properties). You typically depreciate the building’s structural components, including walls, windows, HVAC systems, elevators, 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. Land improvements, such as fences, outdoor lighting and parking lots, are depreciable over 15 years.
Businesses may allocate their buildings’ acquisition or construction costs to real property, which overlooks the opportunity to allocate costs to shorter-lived personal property and land improvements. In some cases — e.g., computers and furniture — the distinction between real and personal property is obvious. But in others the difference becomes fuzzy. Items that appear to be part of a building may in fact be personal property. This type of property can include removable wall and floor coverings; removable partitions, awnings and canopies; window treatments, signs, and decorative lighting.
At the same time, certain items that are otherwise treated as real property may qualify as personal property if their function is more business related than structural. This includes reinforced flooring to support heavy manufacturing equipment, electrical or plumbing installations to support specialized equipment, and dedicated cooling systems for data processing rooms.
Classifying property
Here’s where a cost segregation study comes in. The study uses accounting and engineering techniques to identify building costs that can be rightly allocated to tangible personal property rather than real property. The costs and benefits of the study will depend on your circumstances, but for some businessowners it can be a valuable investment.
The Tax Cuts and Jobs Act (TCJA) enhanced depreciation-related tax breaks, thereby enhancing the benefits of a cost segregation study. Among other things, the act permanently increased limits on Section 179 expensing, which lets you immediately deduct the entire cost of qualifying equipment and other fixed assets up to the specified thresholds.
The TCJA also expanded 15-year-property treatment to apply to qualified improvement property. Previously, this tax break was limited to qualified leasehold improvement, retail improvement and restaurant property. The act also temporarily increased first-year bonus depreciation to 100 percent, up from 50 percent.
Substantial savings
Businesses still have time to enjoy the benefit of faster depreciation on items that were incorrectly assumed to be part of the building for depreciation purposes. You don’t have to amend your past returns (or meet a deadline for claiming tax refunds) to take the depreciation. Instead, you can take steps on the next tax return you file, resulting in “automatic” IRS consent to a change in your accounting for depreciation.
Cost segregation studies aren’t for every business. In some cases, the costs of the study may exceed the tax savings. Find out whether it’s right for you by contacting TrueBlaze Advisors.