Cost Segregation Studies Save Real Estate Even More Taxes Than Before, Thanks to TCJA

Since their introduction in 1997, cost segregation studies have allowed developers and property owners to accelerate their tax deductions through depreciation on both developments and acquisitions.

But with the implementation of the Tax Cuts and Jobs Act (TCJA) in 2017, these studies are even more valuable now than they were before.

A cost segregation study allows the owner or lessee of real property to separate the purchase price, costs to construct a building, or improvements made to a building, along with other assets designated as “personal property.” These assets can then have their depreciation schedules shortened, thereby reducing the owner or lessee’s tax obligations.

“Cost segregation studies identify assets whose depreciable lives can be set at five, seven or 15 years, as opposed to the building they’re attached to, which would be depreciated over 27.5 or 39 years,” said Marc Wieder, Partner and Co-Practice Leader, Real Estate Industry Group for Anchin, Block & Anchin LLP Accountants and Advisors.

Cost segregation studies allow property owners and lessees to take accelerated depreciation and shorter lives on many of the assets identified in the study and to allocate costs to specific building systems such as HVAC systems, elevators, escalators, plumbing and electrical systems. Allocating costs to these specific building systems allows the property owner to write off the remaining cost basis of the system when it is replaced. Without this study, the owner would be unable to identify the cost of such systems.

Now, with the TCJA in effect, a taxpayer can also take bonus depreciation on assets that were previously owned by someone else. This means that if you purchase real property that was improved by previous owners and you do a cost segregation study on that property, you can take bonus depreciation on the assets that have a depreciable life less than 20 years. For assets placed into service after Sept. 27, 2017, unless subject to a binding contract dated prior to that date, the bonus depreciation is 100 percent. For assets placed into service prior to that date, the bonus depreciation is 50 percent.

The TCJA includes many other provisions that need to be taken into consideration regarding how to take bonus depreciation.

“A real property owner subject to the interest limitation rules under the TCJA who elects to take interest expense that exceeds the allowable 30 percent must elect the ADS system of depreciation,” said Wieder.

“This system precludes the property owner from taking depreciation on qualified improvement property—which, until the law is corrected, is not allowed anyway. However, it does allow the property owner to take bonus depreciation on five-year and seven-year assets. Therefore, a cost segregation study can still be worthwhile.”

The TCJA is complicated, especially given how certain provisions of the law interact with other provisions, making planning more important than ever. Still, since we all like to pay less of our money in taxes, it’s essential for owners and lessees of real property to keep the benefits of a cost segregation study in mind so they don’t inadvertently let those benefits slip away.