Many business owners “do the math” and determine that it makes financial sense to buy the building(s) in which they operate the business, instead of continuing to rent. Generally the analysis they perform to make this decision is focused on real estate prices, current rental and interest rates, and the desire to build equity in the investment.
But why stop the analysis there? Business owners can take the benefit of real estate ownership “to the next level” by squeezing out future tax benefits now by completing a cost segregation study.
As a general rule
The cost of the building is broken down into two buckets, the cost of the land and the cost of the building, with no depreciation deduction allowed on the land and the cost of the building defaulting to a 39-year straight-line method.
The 39-year straight-line depreciation is punitive especially if you consider that most commercial mortgages require a 20-year repayment. Therefore, the building cash flow and the tax attributes are not synchronized.
Cost segregation to the rescue
A cost segregation study is a process whereby you identify and separate tangible personal property components and land improvement costs from the lump-sum building cost. The allocation of costs to personal property and land improvements allows the building owner to depreciate those costs over a shorter life, such as five, seven or fifteen years.
The focus is on the time-value of money with the current deductions and related current tax savings worth significantly more today than in the future. In addition, the time-value of the deduction is accelerated further due to recent tax legislation that has extended and expanded the IRC section 179 expense allowance ($1 million in tax years beginning in 2018) and bonus depreciation (up to 100% on certain qualifying assets).
But I bought my building a couple of years ago: did I miss the benefit?
No, cost segregation studies can be conducted on existing buildings! The study will allow you to “catch-up” by taking a current year cumulative depreciation deduction on the difference between what you could have taken as deprecation, if the assets were properly classified to a shorter life, versus the actual depreciation you took utilizing the default 39-year straight-line method.
What’s the catch?
Really, there isn’t one. Yes, there is a cost to the study and some additional tax preparation time should you “catch-up” on the deduction. However, any preliminary analysis (done for free) of the benefit of a cost segregation study factors in these up-front costs when computing the total potential benefit of doing the study. The up-front tax benefit on the time value of money can be significant.
At the risk of sounding like a late-night TV pitchman, there is more!
A cost segregation study can be expanded to determine prior compliance with the recent repair regulations. In addition to the benefits listed above, you can also utilize the study to determine the cost of structural components and sub-components of a building for which a retirement loss may be claimed by making a partial disposition election when improvements are made to the building. The partial disposition election gives taxpayers the opportunity to claim a retirement loss on the undepreciated portion of any retired portion of a building, such as the roof, windows, doors, and lighting.
A cost segregation study is a clear winner and a must for all building owners. Please contact your Clayton & McKervey representative today so we can coordinate a free analysis of the potential benefits.