The IRS allows the separation of building components so that items such as land improvement and personal property can be depreciated over shorter recovery periods. Recent changes to bonus depreciation doubled the first-year bonus depreciation on certain assets. Although real estate is a rare investment in the U.S. that can be depreciated (cost recovery), there are a number of misperceptions about who can benefit from cost segregation and which properties qualify. If you’re a business owner, commercial property owner or investor, you may be missing opportunities to increase cash flow through accelerated depreciation. Let’s take a look at some common misperceptions surrounding cost segregation.
My Property Is Too Small to Qualify
A common misperception is that only large properties can benefit from cost segregation because they have a smaller tax basis. The cost of the cost segregation study could outweigh the benefit. While this can be true, in many cases, it simply is not so. Even $100,000 properties can benefit because of bonus depreciation. Now that taxpayers can deduct 100% in the first year for purchases of qualified property made between Sept. 27, 2017 and Jan. 1, 2023, these properties can qualify for significant cost savings. Smaller investors can use the deduction to offset other income and gains. This is in addition to regular depreciation for new construction and improvements. Also, used qualified property acquired and put into use after Sept. 27, 2017 can be depreciable if it meets certain requirements.
Industrial Warehouses Do Not Qualify
Since warehouses are not typically comprised of personal property, it might be reasoned that this property would not be a good candidate for cost segregation. But industrial warehouses may have portions of electrical, mechanical and plumbing that do qualify for cost segregation. The ability to identify disposition, repairs and maintenance and minimize recapture through the proper retirement of assets is just as valuable. A cost segregation study makes this possible.
Residential Rental Properties Do Not Qualify
Most people associate cost segregation as a tax tool for commercial property owners. But apartments and rental homes, whether new, purchased or renovated, can and do qualify. In fact, multifamily homes often get overlooked as a candidate for a cost segregation study. While the fundamentals of cost segregation are the same for all commercial properties, there are differences in IRS rules and strategies for attaining maximum tax benefits with multifamily units.
A cost segregation study can identify opportunities for faster depreciation. The latest tax reform made cost segregation more lucrative by doubling bonus depreciation from 50% to 100% and applies to qualifying used property. This offers greater immediate deductions.
Tele-engineering is a virtual approach that can expedite studies. Using their own device, such as an iPad or smartphone for a real-time video conference, Engineered Tax Services can guide clients through a building tour, identifying which images to capture.
It’s Too Late for Sold Property to Qualify
Not so fast! Sold property may still be a good candidate for cost segregation, if you haven’t filed the tax return. As long as you sold the building, there is an opportunity to use cost segregation and begin maximizing tax deductions at ordinary tax rates. Keep in mind, though, that the cost segregation study might increase the gain. The gain may be at a much lower rate, making it a beneficial investment.
I’ll Just Get Taxed More When I Sell
The tax savings realized through cost segregation can be substantial, and these savings can also be reinvested into the property and seen as net present value. The depreciation that is used to offset ordinary income today is currently taxed at 12% to 37%, whereas the recapture is taxed at the 15% to 20% tax rate. The part of the gain equivalent to the depreciation would be taxed at 25%, which is still lower than the tax rates for most individuals. Additionally, you can reinvest your savings through faster depreciation to improve your property, eliminating the need for capital.
Cost Segregation Is Too Expensive
Yes, there is a cost associated with these studies. However, if you can write off a large percentage of your building within five years, the cost is well worth it. To make the investment sweeter, the engineering fees surrounding cost segregation studies are tax-deductible!
Cost Segregation Will Take Too Much Time
A qualified specialty tax expert will take on the majority of the work for the study. The collection of initial information for the study will allow the cost segregation specialists and engineers to generate an estimate of the benefits a study may yield. It will also determine the study’s cost, scope and projected timelines. The type of information that needs to be collected will depend on whether the property already exists or will be constructed in the future. A qualified cost segregation expert will follow an organized plan to collect and analyze information. A high-quality study typically takes four to six weeks.
Remember, all properties can benefit from a cost segregation study as long as they are investment properties, the only properties subject to depreciation. In the current economy, it is even more important to capture opportunities to increase your cash flow. Cost segregation remains one of the largest tax incentives for wealth preservation.
The engineering and tax professionals on the cost segregation team at Engineered Tax Services have helped real estate owners and investors significantly increase their cash flow by identifying and reclassifying assets of their building for faster depreciation. Our team of engineers, CPAs and cost segregation experts will guide you through the process and provide you with the most updated information on accounting rules and tax updates.
Heidi Henderson, executive vice president at Engineered Tax Services, has spent her career in private accounting in commercial real estate, development and construction. She can be reached at 800-236-6519 or hhenderson@engineeredtaxservices.com.
