Commercial property owners may use bonus depreciation to significantly reduce income taxes.
Cost Segregation is not a new concept, but provisions contained within the Tax Cuts and Jobs Act of 2017 have ignited interest and turbo-charged the positive impact significantly. The point source for these changes?
Bonus Depreciation!
Let’s take this a step at a time and start with a basic question. What is depreciation?
Simply put, depreciation is an accounting tool which allows a portion of your asset value to be deducted each year from your generated income, thereby reducing your net income and resulting federal tax burden.
This provides an acknowledgement of the decrease in value of personal property and/or some real property due to wear and tear, aging, functional obsolescence and other factors.
For a long time, straight-line depreciation was practiced, and still is in many instances. This allows you to depreciate your asset over 39 years for standard commercial assets, or over 27.5 years for apartments. Here is an example using rounded numbers for a small office building:
Purchase Price $2,000,000
Land Value $400,000
Depreciable Basis of Improvements $1,600,000
Annual Depreciation $41,025 ($1.6M / 39 years)
So, in the example above, when filing your income taxes for the ownership entity of the asset, you would be able to deduct $41,025 in depreciation from generated income. Since this in essence comes right off your bottom line, you would effectively save over $15,000 in taxes (based on a 37% tax bracket) by utilizing straight-line depreciation. Not bad at all!
Enter Cost Segregation!
Cost Segregation has been around for decades in various forms and iterations, as far back as the late 1950s (Shainberg vs. Commissioner), then on through the 1970s (Revenue Ruling 73-410; Whiteco Industries vs. Commissioner); the 1980’s with the enactment of ACRS and subsequently with MACRS (Modified Accelerated Cost Recovery System) in 1986, impacting assets placed in service after January 1, 1987. It has been continually refined and tweaked by various court cases (notably Hospital Corporation of America vs. Commissioner in 1997).
Cost Segregation provides a way for a knowledgeable individual to break out the components of an asset into the appropriate depreciation life span, allowing for shorter recovery periods and accelerated depreciation. In most instances, this involves parsing the asset into 5, 7, and 15 year depreciation periods, with the remaining long life assets being broken out into the requisite Units of Property as provided for in the 2014 Tangible Asset and Repair Regulation dictates.
Let’s get back to our original example to show the positive effect of Cost Segregation on your bottom line.
Purchase Price $2,000,000
Land Value $400,000
Depreciable Basis of Improvements:
- 5 Year Assets $192,000
- 7 Year Assets $8,000
- 15 Year Assets $208,000
- 39 Year Assets $1,192,000
Annual Depreciation $80,868*
*NOTE that this figure is an average depreciation figure over the first five years of the use of Cost Segregation. Due to the varied nature of the depreciation calculations based on the recovery period, it is impossible to provide a completely accurate number for one year for comparison purposes.
That’s roughly DOUBLE the depreciation you can expect from straight-line depreciation, and could lead to bottom line tax savings of almost $30,000 in the same 37% tax bracket.
And finally, BONUS DEPRECIATION!
Sorry for the delay, but we are finally at the main point! The Tax Cuts and Jobs Act of 2017 contained a provision allowing for 100% Bonus Depreciation for any commercial, for-profit asset placed in service or purchased after September 27, 2017!
This means that for any portion of the asset with a depreciation-life of 20 years or less, 100% of the value can be depreciated in the first year of ownership! Read what the IRS is saying about bonus depreciation here.
For most commercial properties, we typically find assets with a depreciation life of 5 years, 7 years and 15 years, along with the 39 year depreciation life, during the course of our cost segregation studies. Given the new laws, any assets found in those shorter depreciation life categories can be depreciated 100% in the first year of your ownership of the asset.
This can amount to between 25% and 45% of the total asset value, depending upon our findings during the site inspection!
Let’s look at our previous example through the lens of 100% Bonus Depreciation:
Purchase Price $2,000,000
Land Value $400,000
Depreciable Basis of Improvements:
- 5 Year Assets $192,000
- 7 Year Assets $8,000
- 15 Year Assets $208,000
- 39 Year Assets $1,192,000
First Year Annual Depreciation $408,000
That’s about 10 times the first year depreciation available via straight-line depreciation, and more than five times that available from standard cost segregation! In a 37% tax bracket, that equates to just over $150,000 in positive bottom line impact potential!
I’ve purposefully kept these figures on the low side of our findings continuum, with the 100% bonus depreciation representing roughly 25% of the depreciable basis. We often find much more!
The new tax law allows the use of bonus depreciation for only a few years. If you are interested in taking advantage of the new tax laws, protecting your bottom line, and maximizing your cash flow, act now. You may contact here us and request a free preliminary evaluation.
Check out our quick and free tax savings calculator to see how much you can save with a Cost Segregation study using bonus depreciation.