By: Darshan Sheth, CPA
Key Takeaways:
- Commercial building owners can increase value and gain tax benefits by conducting a cost segregation study.
- Personal property can be separated from real property and depreciated over a shorter time period.
- 100% bonus depreciation is no longer available, but currently amounts to 80%, falling yearly until gone.
- Cost segregation studies separate components into personal property, land improvements, building materials, and land to assign values and calculate depreciation.
- First year of ownership is best for cost savings from bonus depreciation rate; subsequent years will not yield the same benefit.
- KRD can help owners conduct cost segregation studies to maximize tax benefits on their properties.
Tax Benefits Are Significant, but Time is of the Essence
Owners of commercial buildings – including rental properties – can find hidden value in their properties and reap tax benefits with a cost segregation study.
A cost segregation study enables building owners to reveal value in their properties by segregating the components of a building that are considered personal property from those that are considered real property. The benefit is that personal property can be depreciated over a shorter time period, allowing the owner to realize tax benefits more quickly.
Buildings used in a trade or business are typically depreciable over 39 years, or 27.5 years for a residential rental property. But there are parts of a building – such as cabinetry, plumbing and flooring – that are classified as personal property for tax reporting purposes. A cost segregation study identifies these components, assigns a value to them, and enables the owner to depreciate those items over a shorter period of time, typically 15 years.
Bonus Depreciation
When components can be depreciated over a period of less than 20 years, they become eligible for bonus depreciation, so the owner can recoup a large share of the components’ value through tax deductions. While 100% bonus depreciation is a thing of the past, for the 2023 tax year bonus depreciation is still at 80%, so the benefits are still significant. But beware, bonus depreciation will drop to 60% in January 2024, and will continue to decline by 20 percentage points annually until it is gone.
A cost segregation study separates assets into several categories, including:
- Personal property, including such items as plumbing and electrical fixtures, cabinetry and flooring
- Land improvements, which may include sidewalks and parking lots
- Building components, including such items as doors and windows
- Land
The tax savings to be realized from a cost segregation study can vary depending on the type of property and the configuration of the buildings involved. A warehouse that doesn’t have many built-in components will yield lower tax savings than a residential rental property, which likely has built-in cabinets, plumbing fixtures and flooring.
Timing a Cost Segregation Study
For most owners, the first year of ownership is the best time to obtain a cost segregation study, as the tax benefits can help offset the cost of purchase. Moreover, since the benefits of bonus depreciation are being phased out over the next several years, taking advantage of it now while it’s at a fairly high rate – and can yield higher tax benefits – makes economic sense.
An owner who buys a new building for $10 million and is able, through the cost segregation study, to allocate 7.5% to personal property can receive a significant tax benefit in the first year. At the current 80% bonus depreciation rate, the depreciable amount on such a building would be approximately $600,000.
A cost segregation study can be done in future years after a building’s purchase but would result in more accounting cost as additional forms needs to be filed along with the tax return.
Additionally, rules applied to the assets will be based on the rules in force when the property was placed in service rather than the year in which the cost segregation study is done. If the cost segregation study is done in future years, any difference in depreciation calculated on the assets based on the cost segregation study vs. depreciation taken would result in additional benefit.
How KRD Can Help
If you would like to discuss a cost segregation study for a building you own or are considering buying, contact your KRD advisor.
