Are You Maximizing Depreciation With Your Current Strategy?

Written by: Kevin McHale, CPA at Anchin

Historically, depreciation has generated tax-advantaged returns for real estate owners and investors. In this article, we will explore various depreciation strategies that can be beneficial for real estate businesses and methods that taxpayers can use to accelerate depreciation.

Additional first-year depreciation (bonus depreciation)

Currently, bonus depreciation enables taxpayers to depreciate 100 percent of the purchase price of qualifying property in the year it’s placed in service. To qualify, the property must have a recovery period of 20 years or less, be depreciated using the modified accelerated cost recovery system (MACRS), and placed in service after Sept. 27, 2017, and before Jan. 1, 2023. For real estate businesses, qualified property typically includes, but is not limited to, furniture, fixtures, land improvements, flooring, cabinets and appliances.

Owners of nonresidential real estate can take bonus on Qualified Improvement Property (QIP). QIP is defined as property that is an interior improvement placed in service after the date the building was first placed in service, made by the taxpayer, and placed in service after Dec. 31, 2017. It does not include elevators, escalators, internal structural framework, and improvements that relate to the enlargement of the building.

Bonus depreciation will gradually be eliminated over the coming tax years. Any qualifying assets placed into service on or after Jan. 1, 2023, will be eligible for bonus depreciation equal to only 80 percent of the purchase price. This will continue to drop by 20 percent per annum until bonus depreciation is completely phased out for assets placed in service on or after Jan. 1, 2027.

Section 179 expensing

Under Internal Revenue Code (IRC) Section 179, eligible taxpayers may elect to expense qualifying property up to certain dollar limitations. To be eligible, property must be purchased for use in a trade or business. Tangible personal property such as furniture, fixtures and carpets are eligible for this deduction. For real estate businesses, the cost of “qualified real property” is also eligible. This includes qualified improvement property as well as the following expenditures made to nonresidential real property after the property was originally placed in service, such as roofs, HVAC, fire protection and alarm systems and security systems. Land improvements are not eligible.

Outside of dollar limitations, there may be limitations for owners or investors allocated this deduction. It’s important to review these limitations before electing to expense under IRC 179.

Cost segregation studies

Cost segregation studies provide real estate businesses with a powerful depreciation accelerator. A cost segregation study identifies and quantifies the various components of both purchased and constructed assets. This quantification enables businesses to depreciate components of their building using shorter lives. If the assets are eligible, businesses can take bonus depreciation on the segregated building components.

Tangible property regulations

The tangible property regulations (also known as the “repair regulations”) are often overlooked and underutilized by real estate businesses. Prior to the implementation of the repair regulations, taxpayers had to capitalize the cost of any asset that had a useful life in excess of one year and depreciate the cost of the asset over said life. There was no clear definition of what a repair was, leading taxpayers to capitalize improvements that can now be expensed. The repair regulations, issued in 2014, provided guidance to taxpayers as to what improvements could be considered a repair and expensed in the year incurred, enabling taxpayers to deduct significant improvements.

Conclusion

This discussion highlights many high-level items real estate businesses should analyze when strategizing on how to maximize their depreciation. It is important for businesses to carefully plan their future projects to ensure depreciation is utilized in an efficient manner.

To read the full article on depreciation strategies click here.

For more information on how your company can maximize depreciation, please contact Kevin McHale, Senior Manager in Anchin’s Real Estate Group at kevin.mchale@anchin.com.