Cost Segregation Studies Have Valuable Benefits Under Both New and Old Tax Rules

With the recent passage of the Tax Cuts and Jobs Act, many companies are in a crunch to maximize their 2017 tax year deductions before tax rates drop and reduce the value of their deductions. Cost segregation studies are a valuable tool that can help maximize both current deductions and future benefits following tax reform. 

A cost segregation study is an engineering-based study that breaks down building or leasehold improvement construction costs to identify portions that can be written off for tax purposes over a shorter life than the restaurant building. Decorative millwork, decorative light fixtures, restaurant-specific electrical and plumbing work, signage and fire suppression in the kitchen are a few examples of items that are identified in these studies for accelerated write-off.

 

Maximizing 2017 Deductions

If you constructed any buildings or had a buildout completed in 2017, a cost segregation study can maximize the amount of depreciation expense captured on your 2017 tax return. Building or leasehold improvements prior to 2018 could have a tax life of 15 or 39 years depending on the nature of the construction and the location of the restaurant.  A cost segregation study identifies construction costs that can be taken as five-year, seven-year and 15-year assets, which typically shifts a significant portion of the depreciation deduction into the early years of the assets being in-service.  The portion of costs that shift to shorter-life assets are eligible for bonus depreciation (50 percent under the pre-tax act rules), with the remaining cost taken over the shorter tax life. 

For buildings or leaseholds in service before 2017 that have been depreciating over 15 or 39 years, performing a cost segregation study can determine how much depreciation should have been taken if the study was completed in the original year in service. Once that number is compared to the amount of depreciation that you actually have deducted to date, the difference can be captured as a deduction on the 2017 tax return to “catch-up” the cumulative depreciation not previously deducted. 

 

Realizing New Benefits

Under the new tax law, which has more favorable bonus depreciation rules and recognizes restaurant building as 39-year assets (15-year life for restaurant buildings was eliminated), cost segregation studies provide value in a different way. With bonus depreciation going from 50 percent to 100 percent on eligible assets, the benefits of performing a cost segregation study increase. For example, a cost segregation study on a $3 million building placed in service in 2017 that identifies $800,000 of five-year assets creates roughly $480,000 of depreciation in year one (assuming the 50 percent bonus, plus 20 percent depreciation on the remaining balance). Under the new 100 percent bonus depreciation rules, if the building was acquired and placed in service in 2018, the entire $800,000 of a five-year asset can be depreciated in the first year for federal tax purposes. The end result: every dollar identified in a cost segregation study for five-year, seven-year and 15-year assets for your business are now eligible for a 100 percent bonus depreciation expense.

It’s important to note that many states do not allow the bonus depreciation to be taken in the year that is it captured for federal tax purposes; they will require you to recalculate the depreciation for state taxable income as if the bonus was not taken.

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