Have you constructed, acquired, expanded or made improvements to real estate? You’ll want to look into using a helpful tax planning tool- a cost segregation study. Here’s why.

What is a cost segregation study?

A cost segregation is a tax planning tool that allows businesses who have constructed, acquired, expanded or made improvements to any kind of real estate to increase cash flow by accelerating depreciation deductions. When a property is purchased, it includes the building structure and also includes all of its interior and exterior components.

Most cost segregation studies will generate anywhere from 20% to 40% of interior and exterior components that fall into asset categories that can be depreciated much quicker than the actual building structure. A cost segregation study breaks out the construction cost or purchase price between asset classes with shorter depreciable lives and the actual building component which is depreciated over 39 years for commercial property.

What’s the benefit?

The primary benefit of a cost segregation study is to identify all of the costs that can be depreciated over 5, 7 and 15 years. This is important because the Tax Cuts and Jobs Act allows businesses to immediately deduct 100% of the cost of these types of eligible property in the year it is placed in service through tax year 2022. The amount of allowable bonus depreciation is then phased down over four years: 80% will be allowed for property placed in service in 2023, 60% in 2024, 40% in 2025, and 20% in 2026.

How could the change in congress impact this?

There is also uncertainty depending on which political parties hold the various branches of government, as to whether the bonus depreciations rules will be altered and or repealed. All of these factors should encourage businesses to take advantage of the 100% bonus depreciation before the phase down process starts in 2022 by having the cost segregation study break out eligible property which will provide immediate accelerated depreciation deductions. These depreciation deductions will reduce taxable income and reduce the amount of cash needed to pay taxes.

Section 163(j) business interest expenses limitation

There is also a second benefit to accelerating depreciation by utilizing a cost segregation study which is related to the Section 163(j) business interest expense limitation which was also part of the Tax Cuts and Jobs Act. Sec. 163(j) provided that business interest expense, with several exceptions, was limited to 30% of the adjusted taxable income (ATI) of the business. ATI was defined as tentative taxable income before interest expense, taxes, depreciation and amortization. As part of the CARES Act enacted in March of 2020 the limit was raised for most taxpayers from 30% of ATI to 50% of ATI for tax years 2019 and 2020.

One of the most important parts of this calculation is the add-back of depreciation to arrive at ATI. Depreciation can be added back to tentative taxable income only during tax years beginning before January 1, 2022. This provides another incentive for taxpayers to accelerate depreciation to tax periods prior to 2022 to allow as much interest deduction as possible before the taxpayer friendly add-back provision is no longer available.

This a great opportunity for commercial real estate businesses to reduce tax obligations for 2020 and beyond. Our real estate specialists can help you determine if a cost segregation study would be beneficial for your property. Please contact us for more information.