Cost Segregation Studies Just as Significant Post-Tax Reform
Many Hamilton businesses were excited when the Tax Cuts and Jobs Act of 2017 (TCJA tax reform) was passed into law. The changes resulted in significant tax savings for many companies. The more compelling changes included an overall reduction of the corporate tax rate to a flat 21% for C Corporations, the introduction of the Qualified Business Income Deduction (Section 199A) for pass-through entities and other unincorporated businesses, an increase in Bonus and Section 179 Depreciation. Other business deductions including the meals and entertainment deduction, Domestic Production Deduction, and business interest were either reduced, eliminated or became subject to limitations. The goal of these changes was to stimulate and invest in jobs and the economy as well as make US businesses more competitive globally as far as taxes are concerned.
Historically, the main reason one would engage in a cost segregation study was to analyze components of a commercial property that would be depreciated on a straight-line basis over 39 years and extract out components that could be written off over shorter lives at accelerated rates. That would bolster deductions for tax purposes while reducing taxes and adding back tax dollars to cash flow. With the favorable depreciation changes and lower tax rates, many owners and other investors in commercial real estate and construction companies might ask whether cost segregation studies are still as beneficial and a worthwhile endeavor. The fact is that these studies are as important as ever and can still reap substantial savings and inject significant cash flow back into an enterprise. Outlined below are some key points for consideration.
Key Tax Reform Changes
There were several changes ushered in through tax reform, which have made cost segregation studies more valuable.
- Section 179 Changes – Allows commercial property owners to take a deduction for the acquisition and installation of certain qualifying property (including roofs, HVAC, fire, security and alarm systems as well as certain interior improvements) not previously allowed. Under tax reform, the deduction increased from $500,000 to $1M and the phase-out threshold increased from $2M to $2.5M.
- First-Year Bonus Depreciation – Bonus depreciation is very similar to Sec 179 in that it enhances first-year depreciation. Recently, bonus depreciation property needed to be new whereas Sec 179 could be new or used. Now, in many instances, bonus depreciation can be elected for used property as well. With the tax law change, bonus depreciation does phase down by 20% each year beginning in 2023 and is scheduled to expire after 2026 unless it is extended. Another advantage is that one could use bonus depreciation for enhanced deductions on improvements to real property whereas one could not with Section 179. This is because a couple of years ago, many types of improvements were recharacterized as fifteen-year property. Previously, they had been 39-year property. As a result, with 50% and then 100% bonus rules, write-offs of improvements could be accelerated. The problem is that in writing the tax reform act, Congress inadvertently allowed much improvement property to revert back to the 39-year property, which is the life used for commercial buildings themselves, thereby eliminating the ability to utilize bonus depreciation for many improvements or so it would seem. The rules defining whether improvements are part of the real estate or personalty are unclear at best and often based upon whether the improvements are permanent or removable. When a building is to be purchased or major improvement is planned, obtaining a cost segregation study may be well worth the investment.
Impact on Cost Segregation Studies
Cost segregation studies have traditionally been a useful tax planning tool for those in the real estate and construction industry. The benefits of a study include increased cash flow, finding missed deductions, and leveraging shorter depreciation schedules. The changes outlined above increase the tax-saving potential.
The changes from tax reform have made cost segregation studies more beneficial and compelling. If you have acquired property within the last few years and have not conducted a study, now is the time to do so. For questions about the changes, or if you need assistance with a study, Klatzkin can help. For additional information, call us at 609-890-9189 or click here to contact us. We look forward to speaking with you soon.