Cost Segregation Studies, Tax Asset Basis, and Bonus Depreciation

Do you own or plan to purchase rental real estate? Are you looking for tax planning opportunities? Here is an idea you may not have heard about before: cost segregation studies.

Cost Segregation Studies

Cost segregation studies are an engineering-based approach to allocating your purchase price into various asset-depreciable life categories. Previous methods separated building from land and depreciate the building over 27.5 or 39 years depending on if it was a residential or commercial building.

The study separates Code Section 1245 personal property from 1250 real property. The benefit is that personal property has a shorter depreciable recovery life than real property. This could mean writing off an asset over 5 years versus 39 years. The benefit is faster depreciation expense and thus greater short-term cash flow (tax savings).

Bonus Depreciation

Current law allows for bonus depreciation on assets with a tax life of 20 years or less. Bonus depreciation is a concept that has come and gone to various degrees over the years. Which bonus applies to you depends on the year the asset was placed in service. Here is the bonus depreciation schedule.

Previously, bonus depreciation was only allowed for “original use,” meaning the first-time buyer. The law was later amended to include used assets. This made cost segregation studies even more advantageous.

What does 60% bonus depreciation look like for a 5-year asset in real practice? Let us say the study allocated $100,000 of your purchase price to carpeting. You would get a first-year write-off of $68,000 (Bonus depreciation of $60,000 ($100,000*60%) plus regular depreciation on the remaining tax basis of $8,000 ($100,000*40%*20%). Without separating the carpeting, this would be written off over 27.5 years in a residential setting for $1,970 in first-year depreciation.

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Another benefit is if you replace items in later years. For example, the study allocates $150,000 to roofing and later the roof is100% replaced. The cost of the new roof would need to be capitalized and depreciated. However, the remaining tax basis of the old roof could be written off.

What if you purchased a building in a previous year? There are avenues to “catch up” on the deprecation that you could have taken but did not. We can do this through an Application for Change in Accounting Method.

Is a cost segregation study always beneficial? Like everything else in taxes, it depends on facts and circumstances.

Please reach out if you are a real estate investor and are looking for other ideas tax planning ideas. Our knowledgeable real estate professionals are ready to help.