100% Bonus Boosts Cost
Segregation Benefits
By James Su
Businesses in asset intensive industries like manufacturing
and real estate have for decades looked to Cost Segregation
(“Cost Seg”) as a useful tool for accelerating depreciation
deductions. Accelerated depreciation allows businesses
to defer tax liability and offset the high cost of acquiring
capital assets. By increasing first year Bonus depreciation
(“Bonus”) from 50% to 100%, the Tax Cuts and Jobs
Act of 2017 (“TCJA 2017”) further enhances already
significant benefits of Cost Segregation studies.
Cost Segregation Overview
A Cost Segregation study is a detailed analysis of real
estate acquisition and construction costs that allows real
estate owners to identify and quantify property eligible
for accelerated tax depreciation. Cost Seg studies take
building costs depreciable over 39 years or 27 ½ years,
and reclassifies certain building components instead
as personal property depreciable over 5 or 7 years, or
as land improvements depreciable over 15 years. By
shortening the tax lives and accelerating depreciation
methods, taxpayers reduce income tax liabilities by
maximizing immediate tax deductions. Cost Seg studies
are often completed for core asset classes like office, retail
and multi-family, but, can also apply to less common
building types, including factories, cinemas, self-storage
facilities, gas stations, and even golf courses.
Cost Segregation is a well-established tax planning
strategy utilized by savvy owners of commercial and
rental real estate. The popularity of Cost Seg studies
has soared over the last two decades, in part due to the
availability of and correlation to Bonus depreciation. The
core principles behind Cost Seg have remained mostly
unchanged, but, resulting tax benefits have increased
as Bonus rates have risen. Near term cash flow benefits
resulting from Cost Seg studies increase in almost direct
proportion to Bonus depreciation rates.
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BPM Real Estate Insights
Bonus Depreciation
Bonus depreciation (“Bonus”) is a tax incentive that
allows businesses to immediately deduct a portion of
the cost to acquire eligible business property. Bonus-
eligible property includes furniture and equipment used
for business, as well as “personal property” and land
improvements commonly identified in Cost Segregation
studies. The increased rate of Bonus at 100% effectively
allows building costs reclassified through Cost
Segregation studies to be expensed immediately (whereas
they would ordinarily be capitalized then recovered over
periods as long as 39 or 40 years).
For each dollar of property reclassified through Cost Seg
(under 50% Bonus), a taxpayer would historically have
expected to realize somewhere between 11 to 20 cents
of net present value (“NPV”) tax benefit (on average
16 cents of benefit per dollar). With 100% Bonus, that
NPV benefit increases to about 25 cents per dollar (a
54% increase over benefits under 50% Bonus). Under
the outgoing 50% bonus rules, Cost Segregation on a
commercial building will typically yield on average
about $40,000 of tax benefit per $1 million spent on
building, in the year the property is placed into service.
Under 100% Bonus depreciation, 1st year tax benefits go
up to about $70,000 per $1 million spent on building.
In short, Cost Segregation studies under the new 100%
Bonus rules will net a taxpayer about 75% more tax
savings up front, and overall 54% more in NPV savings
over time, compared to the outgoing 50% Bonus rules
from last year. And, unlike the Section 179 deduction,
Bonus does not have dollar limits, making it much more
powerful with savings potentials limited only by the
taxpayer’s ability to utilize deductions.
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