There’s so much to consider when embarking on a new construction project. One factor that should always be taken into account is the opportunity for tax savings. There are many favorable tax strategies that can boost a project’s bottom line, and often the key to employing them most successfully is simply good planning. Cost segregation is one of these powerful strategies, and it is primarily used to accelerate depreciation deductions, though it has myriad applications. The benefits of cost segregation on acquisitions, new construction and renovation projects result in significant tax deferrals and improved cash flow.

Cost segregation is an IRS-recognized tax benefit strategy in which
specific components of a building or improvement project are identified and reallocated into modified cost recovery system (MACRS) class lives for federal tax purposes. Treating the assets as personal property or land improvements allows depreciation of these assets to be accelerated. Personal property depreciates over 5 or 7-years and land improvements depreciate over 15-years. This is significantly quicker than conventional 39-year depreciation period.

The taxpayer is not creating new deductions, but is shifting the deductions towards the earlier years of ownership. This front-loading of depreciation offsets income and lowers the tax burden. This accelerated depreciation can create $30,000-$200,000 in federal tax benefits for every $1,000,000 invested into a property.

Accelerating depreciation is just the beginning — there is an additional incentive called “bonus depreciation.” The recent tax reform permits the immediate write-off of the full purchase price of eligible assets in addition to other depreciation. New and used assets with class lives of 20-years or less are eligible for this “bonus” which significantly boosts tax savings. Cost segregation is the primary vehicle used to determine and document which assets have eligible class lives and are therefore eligible for this powerful incentive. The Table lists the established bonus depreciation rates through 2026. The rate for eligible assets placed-in-service through 2022 is 100%, followed by a subsequent decline.

What is Eligible for Cost Segregation? What Kind of Assets Can Be Assigned Shorter Class Lives?

Eligible structures include:
• Buildings and facilities placed-in-service after 12/31/1986
• Renovations and additions completed after 12/31/1986

Ideally, it’s best to perform a cost segregation study immediately after a property is placed-in-service, to maximize savings from day 1. However, if that was not possible, the IRS allows for recapture of the benefits from previous years using a “look-back” cost segregation study. By reclassifying assets to their correct lives, entities can “catch-up” on all the depreciation they would have gotten had the study been performed on day 1!

Many building components can be moved into shorter class lives, thus undergoing accelerated depreciation and becoming eligible for bonus depreciation. A list of some commonly segregated assets is in the sidebar.

How Can I Make the Most of Cost Segregation?
Three words – plan, plan, plan. Thinking ahead is the key to leveraging all possible opportunities. Be sure to let your accountant know that you’re planning to buy, build, or renovate. They will be able to help you maximize all relevant tax strategies.

There are steps you can take to improve the outcomes even before construction begins. For example, if you’re building from the ground up, try to select materials that are eligible for rapid depreciation when possible. For example, ceramic floor tile depreciates slowly over 39-years. However, resilient tile flooring has a short
5-year class life.

Another planning point relates to EPAct 179D, a one-time deduction benefit that permits the accelerated depreciation of newly constructed or renovated energy-efficient property that meets a certain standard. If you are constructing or renovating property, consider incorporating energy-efficient improvements in
lighting, HVAC, or building envelope — you might be eligible for a depreciation deduction of up to $1.80/improved square foot.

If you’ll be disposing of a lot of assets, you’ll want to plan for that too. If an asset no longer exists, the remaining depreciable basis of that asset may be written off in the year the asset was removed. This is called Partial Asset Disposition. You need to plan ahead and perform a cost segregation study to provide the data supporting this write-off.

Note:

5 or 7-Year Assets
■ Dedicated outlets
■ Breakroom counters, cabinets, sinks
■ Specialty lighting and plumbing
■ Security camera systems and keypads
■ Fire extinguishers
■ Paddle Fans

15-Year Land Improvements
■ Paved parking lot
■ Sidewalks
■ Drain pipes, sanitary lines
■ Landscaping
■ Retaining walls
■ Stormwater retention systems

Have a question? Contact Bruce Johnson, Capstantax.com.

Article written by Terri S. Johnson, CRE, is a co-founder and partner at Capstan Tax Strategies. Terri and team works closely with commercial real estate owners and accounting firms to provide practical, creative, and customized engineering-based tax solutions.
Visit: capstantax.com to learn more.