Since 1997, commercial property owners have been able to defer, and in some cases, save hundreds of thousands of dollars in income taxes by applying a cost segregation study to their properties.
The new tax law called The Tax Cuts and Jobs Act (TCJA) passed in late 2017 has made commercial real estate ownership even more favorable by expanding cost segregation and reducing income taxes and increasing the owners’ after-tax cash flow.
Here’s how it works: U.S. Tax Code states that if you own a commercial building or income-generating property, you can depreciate the building and improvements in one of two ways:
Straight line 39 years for commercial properties or 27.5 years for multifamily residential)
Accelerated depreciation (cost segregation method)
Cost segregation is an application that utilizes an engineering-based study to separate the building’s personal property (from real property) into its individual components and reclassifies the personal property into shorter class lives. This results in increasing depreciation in the early years and paying less income taxes. For example, items such as cabinets, millwork, flooring, and specialty lighting/plumbing may be reclassified into five-year lives while land improvements such as site work, paving, landscaping are reclassified as 15-year life.
These shorter life items may represent 20 percent to 40 percent of the whole building, making a significant difference in the overall depreciation schedule.
Prior to the TCJA, those items identified with lives shorter than 20 years were eligible for bonus depreciation and 50 percent of their value could be taken in the first year of use on new construction and renovations. The TCJA expands bonus depreciation from 50 percent to 100 percent and after Sept. 27, 2017, including not only newly constructed properties/renovations but also the acquisition of existing properties. The TCJA means that all components with a life shorter than 20 years can be deducted in the first year of ownership and carried forward until the depreciation is exhausted.
All types of commercial and leased residential property can take advantage of this tax strategy, including office buildings, warehouses, self-storage facilities and restaurants, as well as apartments and owner-occupied properties. Newly constructed and recently acquired properties benefit significantly, as well as properties acquired several years ago.
While more complex properties with higher-priced finishes offer the greatest benefits, basic property types such as warehouses can also yield excellent results. Multifamily residential properties with kitchens, baths and additional finishes are outstanding prospects.
