Typically, building costs are classified for federal income tax purposes into three categories. Each has a different depreciation recovery period and method under the Modified Accelerated Cost Recovery System (“MACRS”):
TANGIBLE PERSONAL PROPERTY
Depreciates Over 5 OR 7 YEARS
At a 200% Declining BalanceLAND IMPROVEMENTS
Depreciate Over 15 YEARS
At a 150% Declining BalanceRESIDENTIAL RENTAL – REAL PROPERTY
Depreciates Over 27.5 YEARS
Straight Line (Residential)COMMERCIAL – REAL PROPERTY
Depreciates Over 39 YEARS
Straight Line (Commercial)
In most cases, when a property is placed in service, the straight line method is used. In some cases, the obvious short life items are separated out and the remainder depreciates over the long term straight line method.
By reclassifying components from 39 year real property (subject to straight line) to five or seven year personal property (qualifying for 200% Declining Balance), the recovery period is greatly compressed. In addition to the reduction in the recovery period, all five and seven year property is depreciated at a 200% declining balance which further accelerates the depreciation. This provides the building owner the ability to greatly increase the depreciation for a property and thus significantly reduces the building owners taxable income and current income tax liabilities.
Our Engineering Based Cost Segregation Study will help identify items that should be properly classified as tangible personal property or land improvements, rather than real property that is depreciated over 39 years. The tax benefits begin in the first tax year and continue throughout the depreciable life of the identified assets.
For example, a taxpayer that owns a manufacturing facility could classify the cost of certain equipment foundations, exhaust and ventilation systems, and electrical distribution as tangible personal property. Certain site improvements such as landscaping, underground utilities, and site lighting could qualify as land improvements.
Knowing the difference is critical. So is the ability to support and document the decisions. That is why you need expert advice. Identifying items to be reclassified is only half the battle. The other half is to determine the costs legitimately associated with each item. The complication is locating single-item costs. For example, suppose you know that a portion of your facility’s electrical distribution for specific manufacturing equipment should be in the shorter-life category. You look at the contractor’s charges under electrical and find that all the electrical costs for the job are bundled into a single number, but you need only the cost associated with electrical distribution serving manufacturing equipment.
Our cost segregation specialists can un-bundle the costs and assign them appropriately – not only the direct costs, but also a portion of any indirect costs, such as architect and engineering fees, contractors general conditions, permits, bonds, etc. We have extensive knowledge of construction methods, engineering, and the Internal Revenue Code including the applicable Tax Court cases and Revenue Rulings. Our expertise is the ability to read blue prints and fully understand construction materials, cost, and taxation. We are consultants that bridge the gap between your accountants and the construction team.
Contact Us to learn more.