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Take Advantage of a Cost Segregation Study Before Bonus Depreciation Phases Out

April 22, 2024

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.

A cost seg study is a valuable tax planning tool that allows you to increase cash flow by accelerating depreciation deductions. How do you get started with a cost segregation study? What are the benefits? We explore here.

What is a cost segregation study?

For tax purposes, commercial property is typically depreciated over 39 years and residential property is depreciated over 27.5 years. Given that these are long periods of time, many buildings (or businesses) are sold before the property is fully depreciated.

A cost segregation study identifies building components that can be depreciated over a shorter time period — typically 5, 7 or 15 years, depending on the type of asset, allowing your business to defer income taxes and increase cash flow.

Cost segregation studies offer a variety of benefits for acquisition, renovation or construction projects and include the following:

  • Tax savings
  • Cash flow improvement
  • Accurate asset valuation
  • Compliance and audit protection
  • Financial reporting and planning

What is bonus depreciation?

Bonus depreciation allows businesses to deduct a larger portion of the cost of qualifying assets immediately, rather than spreading it out over several years.

What’s new with cost seg studies in 2024?

December 2017’s Tax Cuts and Jobs Act (TCJA) extended bonus depreciation through 2026. Additionally, TCJA increased bonus depreciation to 100% for 2018-2022, with a gradual reduction of 20% annually from 2023.

This has many wondering “As bonus depreciation phases out, are cost segregation studies still advantageous?”

YearBonus Value- How much of the cost of qualified property can be written off?
9/18/2017- 12/31/2017100% (50% election)
1/1/2018- 12/31/2022100%
“If you are thinking of embarking on a significant acquisition or renovation, it is wise to act sooner rather than later to take advantage of bonus depreciation which, at 60% rates during 2024, is still very favorable. The savings potential through a cost seg study is definitely worthwhile!” -Meyer Levy

What is MACRS?

  • MACRS, or Modified Accelerated Cost Recovery System, is a method used in the United States to depreciate assets for tax purposes.7 year property: Year 1 MACRS rate: 14.29%
  • 15 year property: Year 1 MACRS rate: 5%

Picture this:

In 2024, Melanie bought a commercial building to establish her veterinary clinic. She paid $1.2 million for the building. Melanie would receive an annual $30,769 deduction for depreciation for 39 years under the straight line depreciation method.

However, Melanie has a cost segregation study performed in 2024, which identifies $400,000 in building components that can be depreciated over a shorter time period, specifically $200,000 as 7-year property and $200,000 as 15-year property.

As a result of the cost seg study, $240,000 of the $400,000 ($400,000 * 60%) would qualify for bonus depreciation. In addition, the remaining $80,000 of the 7 year property is depreciated over 7 years following MACRS and similarly $80,000 of the 15 year property is depreciated over 15 years.

Despite the gradual bonus depreciation % reduction, by carrying out the cost seg study, the 2024 benefit for Melanie is still significant, as illustrated below:

  • Depreciation without a cost seg study - $30,769 (straight line depreciation method)
  • Depreciation WITH a cost seg study - $255,432 (broken down here)
    • 7 year property- $200,000 * 60% bonus depreciation= $120,000 PLUS The remaining $80,000 of property is depreciated under the MACRS rate- 14.29% = $11,432
    • 15 year property- $200,000 * 60% bonus depreciation= $120,000 PLUS The remaining $80,000 of property depreciated under the MACRS first year rate- 5% = $4,000

This is a total savings of $224,663 Melanie achieved by utilizing a cost seg study!

A cost seg study is a very worthwhile tool to accelerate depreciation, reduce taxes and improve cash flow sooner as opposed to spreading the depreciation benefits over 39 years. Do you want to explore the benefits of a cost seg study before bonus depreciation phases out? Contact us. We’re happy to help.

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