With the April tax deadline behind us, the accounting world is finally ready to enter 2018 and tackle all of the "future CPAs' problems" we've been looking forward to, courtesy of the Tax Cuts and Jobs Act.
In doing so, accountants everywhere are now mining the new legislation for creative and advantageous planning opportunities for businesses and their owners. Sometimes, it turns out, we don't have to look any further than the depreciation schedule already sitting in our records.
One of the longtime favorite tax saving tricks for taxpayers owning real estate has gotten its big comeback with the changes in tax law; cost segregation studies have been around for years, however the cost savings from one effective for the 2017 tax year supercharges the power of the technique. So how does a cost segregation study (CSS) work, and how does it fit into a tax minimization strategy?
To understand how a CSS works, you must consider the U.S. tax code's cost-recovery system; a business purchases real or tangible property and then deducts the cost of that property over its pre-defined recovery period. Usually, when a building is purchased, it is treated as one large asset with the longest possible recovery period.
When done properly in accordance with IRS-approved methodologies, CSS's serve as a method of more precisely reclassifying components of a building from real property (with recovery periods of up to thirty nine years) as tangible personal property (with recovery periods of five, seven, and fifteen years).
By shortening the recovery periods of individual pieces of a building, such as its lights, carpeting, landscaping, etc., you can accelerate your depreciation deductions. Personal property in these shorter recovery periods will generally qualify for bonus depreciation, adding to the tax savings.
Due to the expanded applicability of bonus depreciation for assets in service after Sept. 27, 2017, a CSS can identify assets eligible for 100 percent bonus depreciation under the new tax law (an enhancement to the benefit of CSS's available under prior law).
While it may sound like a daunting, time consuming, and costly process to separate out a building into its individual components and put them all in the right cost-recovery buckets (who has time to go around counting light fixtures and doors, right?), it can actually be done in one to two days' worth of on-site fieldwork with the rest of the analysis being conducted at the service provider's office.
Let's run through a quick example. Assume you purchased a commercial rental property for $2,000,000 (exclusive of the purchase price allocated to non-depreciable land) and started renting it on Aug. 15, 2017.
You'd receive depreciation deductions of roughly $19,000 in 2017 and $51,000/year over the default cost-recovery life of thirty nine years.
If you filed an extension and a CSS is completed before your 2017 tax return is filed, we have found in similar properties that your 2017 depreciation deduction could be around $172,000, with deductions of roughly $48,000/year for its remaining life.
Assuming a 40 percent effective tax rate, this would yield an immediate $69,000 tax savings for your 2017 tax return.
There are still significant benefits to performing this study in 2018 if you already filed your 2017 return, but the tax savings are slightly lower because the deductions are worth slightly more in 2017 (before tax rates decrease).
Those who will benefit most from a CSS have business use real property, such as commercial and rental buildings, and purchased these buildings within the last few years.
The benefits of a CSS will diminish as the building is further along in its "normal" depreciation schedule.
Again, a CSS that can be effective for 2017 (if the 2017 tax return is extended) is able to capture an additional benefit.
Next time you're walking through your office building or warehouse, take the time to look at the light bulbs and carpet, and remember that there could be thousands of dollars in tax savings hiding in plain sight.
• Jonathan R. Sniegowski, CPA, MST, tax partner at Mowery & Schoenfeld LLC in Lincolnshire.