What is Cost Segregation?
You spend cash or take out a loan to build, purchase, or renovate your building. However, the default tax depreciation rules require you to spread the deduction over 27.5 years for residential real property or over 39 years for non-residential real property. Thankfully, a cost segregation study can significantly accelerate those deductions for you.
While buildings have long recovery periods, other property types depreciate over quicker timelines. You might also qualify for bonus depreciation on these other property types, which could enable you to deduct up to 100 percent of the expense.
A cost segregation study breaks out those favorable non-structural costs from your building, and a typical study can accelerate between 20 to 35 percent of the total property cost. We can claim these deductions on the current tax return, even if you placed the property in service in a prior year.
The following list includes a few of eligible property types with shorter class lives:
- Floor coverings
- Window treatments
- Qualified improvement property
- Specialty electrical
- Parking lot improvements
Interior Property Improvement – QIP
One property type deserves special mention—Qualified Improvement Property (QIP). This property refers to non-structural improvements made to an interior portion of an existing non-residential building. Thanks to the CARES Act, QIP is now deducted over 15 years rather than the default of 39 years and can receive up to 100 percent bonus depreciation.
Suppose you built an office building in June of this year and spent $750,000 on the construction cost. Under the default depreciation rules, you would only get to deduct $10,417 the first year, followed by $19,231 for the next 37 years, and finally $8,814 in the 39th year.
However, if you perform a cost segregation study and identify 25 percent short-lived property, those figures change to $195,313 the first year, followed by $14,423 in years 2-38, and $6,611 in year 39. The Year 1 tax impact from the cost segregation study at a 29.6% tax rate is $54,700!