If you're uniformly depreciating the cost of your buildings over 30 years, it's time to explore the strategic advantages of a cost segregation study. This approach could significantly accelerate depreciation deductions on specific components of your properties, leading to reduced tax liabilities and enhanced cash flow.
Understanding Depreciation in Real Estate
Typically, commercial properties in real estate are depreciated over 39 years, while residential rental properties follow a 27.5-year schedule. Standard practice involves depreciating the structural aspects of a building - walls, windows, HVAC systems, elevators, plumbing, and wiring. However, personal property within these buildings, such as equipment, machinery, furniture, and fixtures, can often be depreciated more rapidly, usually over five to seven years. Moreover, land improvements like fences, outdoor lighting, and parking lots can be depreciated over just 15 years.
In the realm of real estate, it's common to overlook the allocation of construction or acquisition costs towards shorter-lived personal property or land improvements. This oversight can result in missed opportunities for accelerated depreciation. For instance, items that are not integral to a building's structure, like removable floor coverings, partitions, awnings, and decorative lighting, may actually qualify as personal property.
Additionally, certain elements that typically fall under real property can qualify as personal property if they primarily serve a business function rather than a structural role. Examples in real estate might include reinforced flooring for heavy equipment in industrial properties, or specialized electrical installations in tech-focused commercial spaces.
The Role of Cost Segregation Studies
A cost segregation study, employing both accounting and engineering principles, can accurately segregate building costs between tangible personal property and real property. For the real estate industry, where properties often involve complex and varied components, this study can be particularly beneficial.
Enhanced Depreciation Benefits Under TCJA
The Tax Cuts and Jobs Act (TCJA) has made some favorable adjustments for property owners in the real estate sector. It has permanently increased the limits on Section 179 expensing, allowing immediate deduction of the total cost of qualifying assets. The TCJA also extended 15-year property treatment to qualified improvement property, broadening the scope beyond certain specific property types.
Furthermore, the TCJA has temporarily boosted first-year bonus depreciation, with a gradual decrease planned until 2027. For real estate businesses, these changes could amplify the benefits of a cost segregation study.
Implementing Depreciation Strategies
It's not too late to reap the benefits of accelerated depreciation for items previously misclassified as integral to your building. Real estate businesses don’t need to amend past returns to claim overlooked depreciation. Instead, adjustments can be made in upcoming tax returns, following specific procedures that gain automatic IRS consent for the change in depreciation accounting.
Cost segregation studies can offer substantial rewards, yet they're not universally applicable. It's crucial for real estate businesses to evaluate whether the potential tax savings justify the costs of conducting such a study. Consulting with tax professionals who understand the nuances of real estate investments is essential in making this determination.
Contact us to explore if a cost segregation study aligns with your real estate business strategy. Let's assess whether the potential tax savings outweigh the study's costs, paving the way for enhanced profitability in your real estate ventures.