Business and individual taxpayers that acquire nonresidential real property or residential rental property have an opportunity to reduce the depreciable lives on assets which are considered building components. Certain assets may qualify for shorter lives and recovery periods under MACRS depreciation. The reduction of the asset lives can accelerate deductions to offset income and offer an opportunity to reduce your tax liability.
Background
Generally, the entire cost of residential rental property is depreciated over 27.5 years. Nonresidential buildings, such as offices, retail space, grocery stores, restaurants, warehouses, and manufacturing plants are depreciated using a 31.5-year or 39-year depreciation period, depending upon the date of acquisition. However, under IRS cost segregation guidelines, a significant portion of a building’s cost can be depreciated over shorter periods. Certain building components may qualify for a reduced recovery period over 5-years or 7-years and qualified improvement property and exterior land improvements may qualify for a reduced recovery period of 15-years.
Building components and land improvements. Some examples of building components include: lighting, security and fire protection systems, removable partitions, removable carpeting and wall tiling, furniture, counters, appliances, and machinery (including machinery foundations) unrelated to the operation and maintenance of the building, and the portion of electrical wiring and plumbing properly allocable to machinery and equipment that is unrelated to the operation and maintenance of the building. Land improvements include items such as landscaping, fences, sidewalks, curbs, parking lots, lighting, utilities, signs, swimming pools, tennis courts, and playgrounds.
Qualified improvement property. Qualified improvement property placed into service has a 15-year recovery period. The requirements for qualified improvement property placed in service after 2017 include:
- the property must be an improvement to an interior portion of a building that is nonresidential real property; and
- the improvement must be placed in service after the date the building was first placed in service by any taxpayer.
Analysis and cost segregation study. To determine the potential tax benefit, we can conduct a cost segregation study to identify the separately depreciable components and their depreciable basis. Ideally, a cost segregation study should be conducted prior to the time that a building is placed into service (i.e., when it is under construction or at the time of purchase). If a building is being purchased, the sales price can be allocated between real and personal property in the sales contract. However, a cost segregation study can be completed after a building is placed in service.
State and local real property tax reduction. Cost segregation may also result in the reduction of state and local real property taxes by reducing building costs allocable to real property. In addition, nearly half of all states provide sales and use tax exemptions for tangible personal property used in a manufacturing process or for research and development. A cost segregation study will identify such qualifying personal property. Note, however, that these tax savings depend upon the classification of the property as real or personal by applying applicable state law.
Energy efficient commercial building property deduction. Cost segregation studies may also be useful for purposes of identifying prior and current expenditures related to heating and cooling systems, ventilation, hot water systems, interior lighting systems, and the building envelope that qualify for energy tax deductions. The amount of the deduction available depends on the tax year that the property is placed into service.
Reporting the change to depreciable life. The change to the depreciation lives requires either an amended return or an accounting method change (if it is two or more years after the property is acquired or placed in service). IRS reporting includes the change of basis, depreciable lives, and any adjustments for the impact of the depreciation acceleration from the date the assets are placed in service to the year of the method change.
Contact Us
Please contact our team if you would like greater detail or information on how a cost segregation study may apply to your situation and we can work with you to review opportunities to potentially accelerate depreciation and reduce your tax liability.
