If your business is depreciating the entire construction cost of the building that houses your operation over a 30-year period, a cost segregation study may be worth considering. Running a cost segregation study could allow your business to reduce taxes and boost cash flow by accelerating depreciation deductions on certain items. And as a result of enhancements to certain depreciation-related tax breaks, the potential benefits of cost segregation studies are greater now than they’ve been in past years.
Business buildings typically have a depreciation period of 39 years (for residential rental properties, the depreciation period is 27.5 years). In most instances, a company will depreciate the structural components of a building along with the building itself—this includes walls, windows, elevators, plumbing, wiring, and HVAC systems. Personal property, including equipment, furniture, fixtures, and machinery is eligible for accelerated depreciation, typically over a period of five or seven years, while land improvements (parking lots, fences, outdoor lighting, etc.) are depreciable over a 15 year period.
Many businesses overlook the opportunity to allocate costs to land improvements or shorter-lived personal property and instead allocate most or all of their buildings’ construction or acquisition costs to real property. The distinction between real and personal property is sometimes obvious—as in the case of furniture and computers—but oftentimes, it’s less easy to differentiate between the two. Some items that seem to be “part of the building” (such as removable floor and wall coverings, window treatments, signs, decorative lighting, awnings, and canopies) may actually be personal property.
Items that would otherwise be treated as real property but serve more of a business function than a structural purpose might also qualify as personal property. These items may include plumbing and electrical installations needed to operate specialized equipment, dedicated cooling systems used in data processing rooms, and reinforced flooring to support heavy manufacturing equipment.
Properly classifying property using asset classes
Cost segregation studies utilize both engineering and accounting techniques to identify which building costs can be allocated to tangible personal property and which must be classified as real property. They can be a valuable investment, although the particular facts and circumstances of your business will determine the relative costs and benefits.
Certain depreciation-related tax breaks were enhanced with the passage of the Tax Cuts and Jobs Act (TCJA)—among other changes, the act permanently increased Section 179 expensing limits, allowing for the entire cost of qualifying equipment or other fixed assets to be immediately deducted up to specified thresholds.
Under the TCJA, 15-year-property treatment was also expanded and now applies to qualified improvement property—in the past, this break could only be applied to retail improvement, qualified leasehold improvement, and restaurant property. In addition, first-year bonus depreciation was temporarily increased from 50% to 100%. All of these enhancements may also amplify the benefits of a cost segregation study.
Claim substantial savings now
If your business incorrectly assumed certain items to be part of real property for depreciation purposes, it’s not too late to gain the benefits of faster depreciation for these items. If you’re claiming the depreciation you could have already claimed, you won’t need to amend your past tax returns or meet any deadline for claiming tax refunds. Instead, this depreciation can be claimed by following certain procedures as you file your next tax return. This will “automatically” result in the IRS consenting to a change of your depreciation accounting.
Although they often come with many substantial benefits, cost segregation studies aren’t right for every business. If you’re wondering whether a cost segregation study would be worthwhile for your company, contact us. We can help you judge whether your savings in taxes will outweigh the costs of the study itself.