Take Advantage of 2017 Tax Savings with a Cost Segregation Study
Thanks to the Tax Cuts and Jobs Act (TCJA), tax rates will be lower in 2018. Corporations will receive a 14 percent statutory rate reduction, from 35 percent to 21 percent. Individuals and pass-through entities will receive up to a 10 percent statutory rate reduction, from 39.6 percent to 29.6 percent. Businesses and individuals have an opportunity to take as many deductions in 2017 as possible, even if those deductions reverse in 2018.
If your business recently acquired, constructed or substantially improved a building, a cost segregation study may be a great way to take advantage of these permanent tax savings. A cost segregation study can enable you to identify building costs that are properly allocable to tangible personal property rather than real property and allow you to accelerate depreciation deductions, which reduces taxes and boosts cash flow.
A cost segregation study in action
Here is a simplified example of savings that a business can realize by performing a cost segregation study:
- Company A constructed a non-residential commercial building for $10 million on Jan. 1, 2017. If the entire purchase price is allocated to 39-year real property, the business is entitled to claim $256,410 ($10 million divided by 39 years) in depreciation deductions the first year.
- A cost segregation study might reveal that the business can allocate $500,000 to site improvements and depreciate over a 15-year accelerated life and $1.5 million to five-year property eligible for accelerated depreciation. Both allocation types are eligible for bonus depreciation. Reallocating the purchase price increases the business’ first-year depreciation deductions to $1,162,500.
How a cost segregation study works
Cost segregation is an engineering-based approach to allocate building costs among the various building components to maximize depreciation expenses by classifying qualified assets into shorter lives. The IRS generally allows you to depreciate commercial buildings over 39 years (27.5 years for residential properties).
Companies often allocate a building’s acquisition or construction costs to real property, overlooking the opportunity to allocate some costs to shorter-lived personal property or land improvements. Personal property – movable, decorative or functional as part of the taxpayer’s business – is eligible for accelerated depreciation over five or seven years. Land improvements – fences, outdoor lighting, landscaping and parking lots – are depreciable over 15 years.
- Site improvements – Parking lots, sidewalks, landscaping, sprinkler systems.
- Specialty function HVAC – Climate control for IT rooms, cold storage and walk-in coolers.
- Cabinetry and fixtures.
- Electrical and plumbing for equipment or manufacturing process.
- Removable wall and floor coverings.
- Awnings and canopies.
- Window treatments.
- Decorative lighting.
The amount of costs reallocated to shorter lives varies based on industry, ranging from 10-15 percent for warehouses, to 30-60 percent for manufacturing facilities.
Opportunities to take advantage of right now
- Do a cost segregation study for 2017. Any new assets you placed in service could be an opportunity for cost segregation. You want to maximize your deductions in 2017 while tax rates are high. As the deductions turn in the future, rates will be lower, so it creates a permanent benefit. In order to take advantage of this opportunity, a cost segregation study must be performed and reported on your 2017 tax return, which could be due as early as March 15, 2018, without an extension.
- Take a catch-up adjustment. For pre-2017 additions, a cost segregation study can be performed and a catch-up adjustment can be taken on your 2017 tax return.
- Property to be sold in a few years. If you recently decided not to perform a cost segregation study because you didn’t think you were going to hold the property long enough to justify the cost of the study, the benefit of the permanent tax rate play may make it worth revisiting.
- Certain Q4 2017 acquisitions may be eligible for 100 percent bonus depreciation. Anything you placed in service during Q4 2017, especially anything you acquired (used property is now eligible), might be eligible for 100 percent bonus depreciation. A cost segregation study will maximize the assets eligible for bonus depreciation.
A cost segregation study will take some effort in analyzing your building’s structural components and making your case to the IRS, but it will likely be a worthy effort. Contact Rob Haggerty today to learn how your business can benefit from a cost segregation study.
Download a recording of “Tax Reform: What Businesses Need to Do Now” to learn more about cost segregation, bonus depreciation and other immediate opportunities businesses should consider in light of the Tax Cuts and Jobs Act. Register for our next tax webinar, "Tax Reform: Changes Impacting Business Owners," here.