Let us briefly define cost segregation first.
If you are unaware, cost segregation is a tax strategy used to accelerate depreciation. Thus, reducing your tax liability and increasing your cash flow.
A properly done Cost Segregation Study (CSS) will identify all building components and the cost. This allows a building owner/investor to depreciate new or existing structures in the shortest time permissible under tax laws. To achieve this goal, a study will reclassify the property components into “shorter tax-lives” (5, 7, and 15 year).
Cost segregation leverages the time value of money principal, “a dollar today is worth more than a dollar tomorrow.” One might also say, “a tax deduction today is worth more than a tax deduction tomorrow.” Of course, this depends on your overall tax strategy – but in general this is true.
The bottom line is that cost segregation studies are one of the most valuable tax strategies for commercial property owners, investors and developers. A cost segregation study is used to accelerate depreciation. Therefore, enabling property stakeholders to defer taxes, reduce their current tax burden, and free up capital.
So, what about Bonus Depreciation?
First, 100% bonus depreciation is not the norm. It is used to stimulate the commercial real estate market after economic downturns; like 9/11, the 2008 recession, etc. The 100% bonus depreciation was established in the Tax Cuts Jobs Act (TCJA). It increased what has been normally offered at 30% or 50% in prescribed years. As is stands today, the 100% Bonus runs through 12/31/2022 and then tapers off to 80%, 60%, 40%, 20% and then 0% in the following years.
So, what does 100% Bonus Depreciation do? It allows you to take the accelerated depreciation from “shorter” tax life components all in year one. Versus over their shortened tax lives. For Example, if a CSS identified 30% of a $10mm building into the 5, 7 and 15 year shorter usable life categories. Instead of taking the deductions over the shortened tax lives, it can ALL be taken in year one. So in this example, that’s a $3mm deduction the owner/investor can take in year one. That’s huge.
Back to our question: is 2021 a good year for a Cost Seg Study?
Short answer. Yes.
It is always a good time to do a cost segregation study. And 2021 may produce more reasons to consider taking this 100% bonus depreciation tax benefit now.
There is a lot of talk about the current administration raising the capital gains rate and reducing or eliminating 1031 deferred tax incentives. We will need to wait and see. Regardless, these are two beneficial tax strategies for commercial real estate owners and investors. So considering the proposed tax hikes, one may consider 2021 is an especially good year to do a cost segregation study.
And its not just for properties built or put ‘in-service’ in 2021. But for any property acquired in the past few years where a study was not done. A look-back study will “catch up” on the previous year’s lost opportunity for depreciation deductions, and allow you to take this catch-up depreciation all in the current year.
If you would like to understand this better or discuss your specific situation and tax deduction needs, please reach out to us at firstname.lastname@example.org.