While cost segregation is useful throughout the real estate life cycle, there are certain events that tee up particularly strong cost seg opportunities. These events should automatically trigger consideration of a cost segregation study, since picking the right moment can maximize benefit. Read on for our top 3 cost segregation study triggers – so you can proactively recognize opportunity.
1. New Construction of Commercial Property
Cost segregation takes advantage of the time value of money by front-loading depreciation to the early years of ownership. As such, to maximize savings from Year 1, a cost seg study should ideally be performed as soon as a newly constructed property is placed-in-service.
Consider a newly constructed hotel placed-in-service in 2021 (100% bonus in play.) Capstan was retained to perform a study immediately after construction was completed.
- 400,000 SF with 400 guest rooms, half of which were large suites for extended stay, and half of which were fit out in a very trendy, boutique style. Multiple restaurants and banquet halls.
- Depreciable basis = $92,698,000.
- Engineers moved 27.4% of assets into 5-year personal property
- First-year tax savings = $8,647,253
2. Acquisition of Commercial Property
The Tax Cuts and Jobs Act (TCJA) provided a tremendous boon to taxpayers by making acquired assets eligible for lucrative bonus depreciation. As such, acquiring a property should automatically make a buyer think “cost seg opportunity.”
Consider the following example:
- Triple net lease retail facility acquired in 1/2020
- Depreciable basis: $4.5M
- Cost seg study performed at the time of acquisition
- Engineers moved 15% to 7-year and 8% to 15-year land improvements
This project took place in the era of tax reform, but it’s instructive to compare the actual results with the results that would have been achieved had this project been completed before the TCJA. The impact of bonus on acquisitions takes first-year tax savings to a new level, making property acquisition Capstan’s #2 Cost Seg Trigger.
3. Renovation/Look-Back Study
The first two triggers are placing a newly constructed property in service or acquiring a new property. But what if a property was constructed or acquired years ago? Is there any opportunity left?
There is indeed, and it’s known colloquially as the “look-back” or “catch-up” study, in which you can catch up retroactively on the depreciation you would have achieved had you performed the study when you first constructed or acquired the property. The look-back study can have a dramatic increase in current year depreciation deductions, and they are often prompted by renovations.
In a renovation, the IRS allows taxpayers to immediately write off the remaining depreciable basis of disposed assets. This process is called “Partial Asset Disposition” or PAD, and a cost segregation study is often used to document and support this process. Data generated in the cost seg study can be used to create a disposition table documenting all assets that have been removed and supporting the associated immediate write offs. This will make way for the new assets added to the depreciation schedule.
The utility of PAD elections and look-back studies make renovations the third of Capstan’s Cost Seg Opportunity Triggers. When planning a renovation, cost seg possibilities should always be kept in mind.
One final example – this one to illustrate the utility of cost segregation in a renovation scenario. A local auto dealership was acquired in 2008, and by 2017 the owners were ready to completely refresh their image. They stripped the building down to its shell, and replaced everything — all original siding and signage, doors, windows, roofing, plumbing, flooring, HVAC, electric, and more.
- Depreciable basis = $7,945,574
- Engineers moved 10.3% of assets into 5-year personal property, and 31.3% of assets into 15-year land improvements.
- This accelerated depreciation resulted in first-year tax savings of $590,000.
However, the power of PAD took this dealership’s savings to the next level.
- Engineers documented the disposal of $3M of 39-year assets and $2M of 15-year assets.
- They determined that the remaining depreciable basis of those assets were $2.3M and $800K, respectively, for a total remaining depreciable basis of $3.1M.
- Assuming a 40% state tax rate, that translates to an additional first-year tax savings of $1.24M.
- When the significant PAD results were included, the total first-year tax savings on this dealership exceeded $2M.
If you or your client will be constructing, acquiring, or renovating commercial property – it’s time to think cost segregation. These events are opportunity knocking at your door – and Capstan will help you answer.
**Bonus depreciation will remain at 100% through the end of 2022 and will then decrease by 20% annually. Cost segregation studies will continue to bring benefit at any rate of bonus. However, if an acquisition can be placed-in-service before year end — capturing the higher bonus rate — it is certainly advisable to do so.