Cost Segregation and Sec. 163(j)

How Cost Segregation is affected when a business elects to be a Real Property Trade or Business under Sec. 163(j).

A CPA recently asked us how Cost Segregation is affected when a business elects to be a Real Property Trade or Business under Sec. 163(j). The trade-off of making the election under 163(j) is that the entity must depreciate buildings under ADS.  

Alternative Depreciation System

The most commonly used depreciation system is the general depreciation system (GDS). The GDS allows taxpayers to accelerate the asset’s depreciation rate by recording a larger depreciation amount during the early years of an asset’s useful life.

ADS, or an alternative depreciation system, is another method the Internal Revenue Service allows taxpayers to determine their business assets’ depreciation. The alternative depreciation system enables taxpayers to extend the number of years they can depreciate an asset. The more extended recovery period of ADS usually reflects the asset’s income streams more accurately than the declining balance depreciation. So, this change is a change in accounting method rather than a change in use. 

Electing to Use ADS

If the taxpayer elects to use an alternative depreciation system, they must apply it to all property of the same class placed in service during the same year. It would apply to both the short-life and long-life property, even if there had not been a breakout previously.  Therefore, if a cost segregation study is performed within five years of the 163(j) election, an advance accounting method change would be necessary to change the depreciation method of the personal property.  Filing the advance consent forms to the IRS requires an $11,500 user fee.  If the cost segregation study is done within (or before) the tax year the 163(j) election is made, it doesn’t appear that advance consent would be required.

More Considerations When Doing a Cost Segregation Study

The alternative depreciation system does not apply to personal property since the 163(j) election only relates to real property and qualified improvement property. So, short-life personal property identified by a cost segregation study does not apply to ADS but instead is general depreciation system property with shorter life and is eligible for bonus depreciation. Only the long-life property must remain as ADS property.    

Why M&E Cost Segregation Studies are the Best

Regardless of which accounting system you use, a cost segregation study can help maximize your return by minimizing your tax burden.

·         M&E provides engineer-based studies- not the substandard residual studies that most other firms offer.

·         We provide exceptional customer service and unmatched integrity before, during, and after the study is done. Therefore, clients return to us time and again and recommend us to their family and friends.

·         Our final reports stand on their own. However, in the event of an IRS audit or if any questions are raised, we will defend our studies at no additional cost.

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