Cost Segregation and Qualified Improvement Property Studies
With rising material costs, continued supply chain issues and prolonged labor shortages affecting the construction and real estate industries, now might be a great time to consider a cost segregation study for real property acquired, constructed or improved over the last 10 to 15 years. Cost segregation is a tax planning tool used to defer federal and (possibly) state income taxes and increase cash flow through the acceleration of depreciation deductions on certain, qualifying building components.
A cost segregation study evaluates acquisition, construction and improvement costs that would otherwise be depreciated over 27.5 years (residential real property) or 39 years (non-residential real property). This analysis identifies the components of a building and separates the applicable costs into their proper asset classifications, essentially “slicing up the pie.” This generally results in significantly shorter useful tax lives for these components, such as 5-year, 7-year, and 15-year property, that is depreciated at an accelerated rate in the year the building is placed in service. In addition, taxpayers may be able to benefit from 100% bonus depreciation on certain assets for federal and (possibly) state income tax purposes through the end of this year (December 31, 2022). The amount of allowable bonus depreciation will be reduced over four years effective January 1, 2023: 80% will be allowed for property placed in service in 2023, 60% in 2024, 40% in 2025, and 20% in 2026.
Examples of items that can generate accelerated depreciation deductions include paving, flooring, light fixtures, data and communication ports, and cabinetry, just to name a few. For purchased or rehabilitated properties, there are further opportunities for tax savings. A purchased property can be segregated several years after it was placed into service by the new owner, allowing them to capture additional depreciation from prior periods. What’s more, these additional deductions can typically be claimed on a current year tax return, thus avoiding the time and cost associated with amending returns.
The CARES Act of 2020 authorized Qualified Improvement Property (QIP) to be depreciated over a 15-year tax life and eligible for 100% bonus depreciation. QIP means improvements to an interior portion of a building that is nonresidential real property, as long as that improvement is placed in service after the building was first placed in service by any taxpayer. Examples of these assets include drywall, plumbing, electrical fixtures, and other similar assets. It is even possible that a single property can benefit from both a cost segregation and QIP study!
Major thanks to our new Cost Segregation Leader, Mona Stocki, for her assistance with this post. Please contact her directly to see how a cost segregation or QIP study could benefit your organization and your rental investments.
- Carey M. Heyman, CPA
- Managing Principal of Industry - Real Estate
- CliftonLarsonAllen LLP
- Century City (Los Angeles)
Carey is the Managing Principal of the Real Estate Industry at CLA. He is a trusted advisor with close to 20 years of experience providing accounting, assurance, tax, and consulting services to real estate industry owners, operators, family offices, developers and syndicators. Carey has a strong track record of helping clients build and retain capital by leveraging tax- and cost-saving strategies and employing tax credits and incentives. He also consults with high net worth individuals, large family groups, and owners of closely-held businesses on all aspects of tax planning, estate planning, and retirement planning.
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