How to Boost Your Cash Flow by Utilizing a Cost Segregation Study
If your business is planning to buy, build or substantially improve real property, a cost segregation study can provide you with many benefits including accelerating depreciation deductions, reducing your taxes and boosting your cash flow. Even if you have invested in real property in previous years, you may have an opportunity to do a lookback study and catch up on the deductions you missed. In this article, we will review the benefits of a cost segregation study and key items your business should be aware of if you are planning on investing in real estate in the near future.
How it works
Generally, commercial real property (other than land) is depreciable over 39 years, and residential real property is depreciable over 27.5 years. A cost segregation study identifies real estate components that are properly treated as personal property depreciable over, say, five or seven years, or land improvements depreciable over 15 years. By allocating a portion of your costs to these shorter-lived assets, you can accelerate depreciation deductions and substantially reduce your tax bill. Additionally, if these assets qualify for bonus depreciation, the tax savings can be even greater. We recommend you participate in a study for 2021 as the bonus depreciation is decreasing from a 100% deduction in 2021 to 80% in 2022. The study does not have to be done in 2021, but should be completed before you file your 2021 income tax return
In some cases, assets that qualify as personal property are apparent. Examples include furniture, fixtures, equipment and machinery, but often property eligible for accelerated depreciation is less obvious. For example, building components that ordinarily would be treated as real property depreciable over 39 years may be classified as five- or seven-year property if they’re essential to special business functions.
An example: A manufacturing company built a $20 million factory and placed it in service in June 2021. To accommodate its manufacturing processes, the design called for a reinforced foundation, specialized electrical and plumbing systems, and other structural components closely related to manufacturing functions.
A cost segregation study supports allocation of $6 million of the factory’s cost to these components, which are depreciable over seven years rather than 39 years. As a result, the company increases its depreciation deductions by approximately $774,000 in Year 1, $1.05 million in Year 2 and $895,000 in year three (not counting any available bonus depreciation).
Recovering deductions
Suppose you invested in a building several years ago, but allocated the entire cost to real property. Depending on how much time has passed and the documentation you have available, it may be possible to conduct a lookback study and reallocate a portion of the cost to shorter-lived personal property. Filing a change in accounting method with the IRS will allow you to claim a catch-up deduction for the extra depreciation deductions you missed over the years.
By: Marc Wieder, CPA, CGMA, Partner & Co-Leader of the Real Estate Group
For more information on a cost segregation survey and how a survey can provide your business with substantial savings, please contact Marc Wieder, Partner and Co-Leader of Anchin’s Real Estate Group at marc.wieder@anchin.com, or your Anchin Relationship Partner.
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