Economic stimulus plans enhance cost segregation benefits
Businesses with recent or planned building projects could benefit from "cost segregation" deductions, thanks to provisions in the recent economic stimulus plans.
Cost segregation is a tax strategy that separates building components into various asset classes and allows for the accelerated depreciation of some building components. The accelerated depreciation of the shorter-life asset classes may result in significant tax savings during the early years of a project and improve cash flow at an important time. Cost segregation can provide an even larger impact in 2008 due to recent legislation that revived the bonus depreciation (50 percent first year write off) and enhanced the section 179 expensing election.
The cost segregation process
Cost segregation may be beneficial if you recently purchased or constructed a commercial building or plan to in the future and the total property cost exceeds approximately $500,000. It is important to consider that cost segregation may be applied to a property placed in service in a prior year. The process of realizing the benefits of accelerated depreciation usually entails the following steps:
1. Estimate of the present value effect of accelerated deductions
2. Engineering study and site inspection
3. Documentation to support
4. Reporting on annual tax return
Once the viability of a project is determined, it is important to use an engineering approach to the segregation of property components. This process, which involves review of the facility and blueprints, provides the background work and documentation to support the classification of assets based on the tax law. A more abbreviated approach that does not document the process may not provide the support necessary should the IRS question the position.
During the study, the commercial property will be categorized into four basic categories:
– Personal Property
– Land Improvements
The goal of the cost segregation study is to identify property that can be depreciated as personal property over five or seven years or land improvements which have a 15-year life. The accelerated depreciation of these short-life classes is far greater than if an asset were classified as part of the building resulting in the deduction being spread over 39 years. Typically, by conducting a study, 20 percent to 40 percent of the property value can be reclassified as personal property from real property.
To help stimulate our economy, the 2008 Economic Stimulus Act created a 50 percent first year write off for new tangible personal property with a class life of 20 years or less. For "bonus depreciation" to apply, the property must be considered "first use" property (not used) and placed in service by Dec. 31, 2008. The act also increased the section 179 write-off to $250,000 with the same expiration; however phase-out limits may come into play with larger projects. The result is a great opportunity to increase the first year deduction through cost segregation if you have a new construction project that was completed and placed in service in 2008. For example, if $100,000 of building components is depreciated over 39 years, the deduction is less than $3,000 in the first year. However, if those same components can be allocated to a personal property class, then, after bonus depreciation, the first-year deduction increases to approximately $60,000.
As we start 2009, the bad news is that the economy is still in rough shape. But, the good news is that it creates a possibility that the bonus depreciation and section 179 business incentives will be extended through 2009. Whether you have a property that was constructed in recent years or slated for the future, now is a great time to consider the impact that cost segregation may provide.
James M. Taylor, CPA, CFP is a tax department supervisor at Dennis, Gartland & Niergarth, where he focuses on planning and tax services for business and individual clients. For more information, contact (231) 946-1722 or firstname.lastname@example.org.