Using Cost Segregation Studies and Tangible Property Regulations to Minimize Income Taxes (article)
Now that 2015 tax filing season has come and gone, it is a good time to implement tax planning ideas for YE 2016. Real estate developers have several tax planning opportunities that can lower their income taxes, but two in particular may be worth a closer examination: cost segregation studies and tangible property regulations.
Whether taken separately or conducted concurrently, cost segregation studies and tangible property regulations analysis have the potential to significantly reduce tax liabilities related to tangible property purchases and costs, which could have a positive impact on cash flow. Many of the provisions must be considered before the calendar year end, so now is the time for real estate developers to consider these tax benefits.
Cost Segregation Studies
If you acquired, constructed or renovated commercial or residential property in 2016, a cost segregation study may provide a tax advantage.
A cost segregation study is a combined engineering and tax analysis that breaks down the components of a building into shorter depreciable lives in order to accelerate depreciation deductions. Studies can be performed for newly constructed and existing buildings, including retail spaces, office spaces, hotels, restaurants, apartments, manufacturing facilities and warehouses, assisted living facilities and mixed used facilities. Generally, these buildings include properties with a basis exceeding $1 million.
Even if you haven’t recently constructed or renovated a building, you may still qualify for a cost segregation study. A “look-back” study can be performed to claim depreciation deductions that may have been missed in previous years. Typically, a 20 to 45 percent carve-out can be obtained, depending on the type of property.
Real estate developers may want to consider cost segregation studies sooner versus later. The Protecting Americans from Tax Hikes (PATH) Act of 2015 created an extension of the bonus depreciation tax deduction through 2019. A popular deduction, the bonus depreciation provision allows businesses to deduct 50 percent of the cost basis of qualified property placed in service during that calendar year. Qualified property generally includes personal property, off-the-shelf computer software and qualified leasehold improvements. Effective in the 2016 tax year, additions or improvements to the interior of nonresidential real property also qualify for the deduction.
The extension of bonus depreciation means an additional first-year benefit of expensing 50 percent of qualifying assets is available for 2016. The 50 percent deduction won’t be around forever. In 2018 the bonus depreciation deduction drops to 40 percent of the cost basis of qualified property, and in 2019 the bonus depreciation deduction is 30 percent. Real estate developers looking to use the deduction should put a plan in place for 2016 and 2017 to ensure they receive the maximum benefit from the tax planning provision.
Tangible Property Regulations
The tangible property regulations (TPRs) became effective in 2014 and now govern how renovations are examined for tax purposes. Affecting everything from individuals to C corporations and partnerships, the tangible property regulations create additional opportunities for deductions of repairs, materials and supplies, and routine maintenance for buildings. They also affect dispositions of property subject to the Modified Accelerated Cost Recovery System (MACRS).
Taxpayers apply the regulations to each unit of property to determine if costs related to assets placed in service must be capitalized or expensed. Depending on the type of renovation performed on a property, there may be the opportunity to expense the renovation as a repair and deduct in one year, as opposed to capitalizing and depreciating over a determined number of years. If the opportunity to expense is not possible, the net book value of the assets removed during the renovation may be expensed as a partial asset disposition loss (PAD). Using the PAD, taxpayers can write off the undepreciated cost basis of the components being replaced, such as a roof, elevator or HVAC unit, so long as they capitalize the cost of the new components. This can create significant tax savings opportunities for major repairs and renovations.
Using a cost segregation study can help taxpayers break down their building components into units of property that should be capitalized versus expensed, simplifying the application of the tangible property regulations.
Newly acquired buildings make particularly good candidates for cost segregation studies and tangible property regulations because taxpayers can use the study to assist in the application of the tangible property regulation rules for past, current and future expenditures. A properly performed cost segregation study also helps identify assets that can be expensed as part of a PAD. Retroactive corrections may be available, depending on the facts and circumstances.
Tangible property costs that do not need to be capitalized after applying the tangible property regulations are not good candidates for a cost segregation study because the taxpayer is not capitalizing the costs.
For More Information
Both cost segregation studies and tangible property regulations require an in-depth examination of property and related costs that can strain internal resources. A tax provider experienced with depreciation regulations and opportunities can help ensure you maximize the advantages under both provisions.
For more information about the combined benefits of cost segregation and the tangible property regulations, call or email Larry Rosenblum at 561.994.5050 or contact your local CBIZ MHM professional.