Businesses planning to build, buy or extensively improve real property can benefit from a cost segregation study. It can help businesses reduce taxes, accelerate depreciation deductions and boost cash flow. Lookback studies can also be done for prior years. Some industries that can benefit the most from a cost segregation study are automotive, manufacturing, real estate, restaurants and retail/convenience stores.
How Does a Cost Segregation Study Work?
A cost segregation study identifies real estate components that are properly treated as personal property depreciable over five, seven or 15 years. Other than land, commercial real property is depreciable over 39 years while residential real property is depreciable over 27.5 years. You can reduce your tax bill and accelerate depreciation deductions by allocating a portion of your costs to these shorter-lived assets. The tax savings can be higher if these assets qualify for bonus depreciation.
In some instances, assets that qualify as personal property are apparent but, in some cases, property that is eligible for accelerated depreciation is less obvious. More apparent personal property includes fixtures, furniture, equipment and machinery. While less apparent property could include building components that would be treated as real property depreciable over 39 years, which may be classified as five- or seven-year property if deemed essential to special business functions.
An example of an asset that qualifies would be if a manufacturing company built a $20 million factory and placed it in service in June 2021. To accommodate its manufacturing processes, the factory’s design called for a reinforced foundation, specialized electrical and plumbing systems and other manufacturing related components. An allocation of $6 million of the factory’s cost to these components is supported by a cost segregation study. These costs are depreciable over seven years rather than 39 years. Subsequently, the company increases its depreciation deductions by approximately $774,000 in the first year, $1.05 million in the second year and $895,000 in the third year, not counting any available bonus depreciation.
Can I Recover Deductions from Prior Years?
So what if several years ago you invested in a building but allocated the entire cost to real property? Depending on the amount of time that has passed, along with the documentation you have available, it is possible to reallocate a portion of the cost to shorter-lived personal property by conducting a lookback study. If you apply to the IRS for a change in accounting method, you may be allowed to claim a catch-up deduction for the extra depreciation deductions you missed over the years.
Does My Business Need a Cost Segregation Study?
If you are wondering if your business could benefit from a cost segregation study, contact your BSSF tax advisor to help you weigh the potential tax savings against the cost of a study.
About the Author
Randy Fackler is a Principal and the Tax Director at Brown Schultz Sheridan & Fritz and is one of the key members of the Firm’s Tax Department. He is responsible for managing tax consulting and compliance services for his clients as well as overseeing the tax department.