How Can Real Estate Investors Benefit From Cost Segregation Studies?

  • Tax strategies
  • 9/9/2022
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Key insights

  • Property owners may find tax savings opportunities in the form of accelerated depreciation.
  • Tax laws have changed over the years, and the most recent legislative updates may bring renewed opportunity to review your property through a cost segregation study.
  • Qualified improvement property can include updates such as drywall, plumbing, electrical fixtures, and other similar assets.

Is a cost segregation study right for you?

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Looking to help offset expenditures and manage tax liability for new construction projects or building acquisitions? Consider a cost segregation study. It’s a tax strategy that can provide an immediate return on investment capital in the form of accelerated depreciation.

How does a cost segregation study help?

For federal income tax purposes, non-residential property typically depreciates over 39 years. A cost segregation analysis identifies and separates building components and their applicable costs into proper asset classifications, essentially “slicing the pie.” These building components may then have significantly shorter tax lives, such as 5-year, 7-year, and 15-year property depreciated at an accelerated rate in the year the building is placed in service.

In addition, taxpayers may benefit from 100% bonus depreciation on certain assets, including purchased properties acquired and placed in service after September 27, 2017. Bonus depreciation phases down to 80% after December 31, 2022, and continues to phase down 20% every year thereafter.

Items eligible for accelerated depreciation deductions include assets such as: asphalt paving, flooring, light fixtures, data and communication ports, and cabinetry. Purchased or rehabilitated properties may bring additional tax savings opportunities. A purchased property can be segregated several years after it was placed in service by the new owner, allowing them to capture additional depreciation from prior years. These additional deductions can typically be claimed on a current year tax return.

Changing legislation could bring opportunity

The Protecting Americans from Tax Hikes Act of 2015 created a new category of assets called qualified improvement property (QIP). Such assets were assigned a 39‐year recovery period for tax years 2016 and 2017 and depreciated using the straight‐line method.

The Tax Cuts and Jobs Act of 2017 intended to make QIP assets 15-year property under the modified accelerated cost recovery system (MACRS) eligible for 100% depreciation for assets acquired after September 27, 2017, and placed in service after December 31, 2017. However, due to a technical error, Section 168 was not properly amended to classify QIP as 15-year property. This error meant QIP had a 39-year recovery period and was ineligible for bonus depreciation.

In 2020, the Coronavirus Aid, Relief and Economic Security Act amended Section 168 to list QIP as MACRS 15-year property. With this change, QIP assets are now eligible for 100% bonus depreciation if acquired after September 27, 2017, and placed in service after December 31, 2017.

Review qualified improvement property

QIP assets include improvements to an interior portion of a nonresidential real property building made after the building was first placed in service by any taxpayer. These improvements can include drywall, plumbing, electrical fixtures, and other similar assets.

What’s not included? QIP specifically excludes expenditures for the enlargement of a building, elevators, escalators, or the internal structural framework of a building.

How we can help

If you have a building acquisition, construction project, or renovation, consider how you might be able to defer tax liabilities and provide a cash flow benefit through a cost segregation study. CLA’s cost segregation professionals are experienced in identifying tax savings opportunities, and include both tax and engineering perspectives.

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