By Rolando Garcia, JD, CPA, Shareholder and Houston Tax Advisor

If you have purchased, constructed or remodeled any kind of real estate recently, a cost segregation study could be the key to help reduce your federal and state income tax burden. Due to its complexity, a cost segregation analysis is often overlooked as a tax planning strategy, but legislation included as part of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) makes it a very noteworthy tax savings opportunity for businesses exploring ideas to generate liquidity during the ongoing pandemic.

What Is Cost Segregation?

Cost segregation is an analysis of the components and sub-components of your real estate property (commercial or residential), where reclassifying such components into different classes allows for their depreciation deductions to be accelerated. Typically, a commercial property is depreciated over 39 years, while residential properties are depreciated over 27.5 years. Treating some components as personal property or land improvement provides an opportunity for depreciation to be accelerated over much shorter periods – between five to 15 years – which can generate a significant tax benefit.

Favorable Tax Changes

The Tax Cuts and Jobs Act (TCJA) expanded the availability of bonus depreciation to qualified property placed in service before Jan. 1, 2027, and increased the expensing allowance to 100% for qualified property placed in service after Sept. 27, 2017, and before Jan. 1, 2023. The TCJA also favorably broadened the provision to apply toward acquired properties, which was not previously allowed.

Making bonus depreciation even more valuable, the CARES Act included a technical correction that now gives qualified improvement property (QIP) a 15-year class life, which makes it eligible for the 100% bonus depreciation. (Prior to the CARES Act, the law required QIP placed in service after Dec. 31, 2017, to use a 39-year tax life, making it ineligible for bonus depreciation.) QIPs include improvements made to an interior portion of nonresidential property as long as that improvement is placed in service after the initial date the building was placed in service, with the exclusion of costs associated to elevators, escalators, changes to structural framework or building expansions. Additional “qualified property” for bonus depreciation includes depreciable property with a recovery period of 20 years or less, computer software, water utility property and more.f

The CARES Act also provided taxpayers with a five-year carryback of net operating losses (NOL) generated in a taxable year beginning after Dec. 31, 2017, and before Jan. 1, 2021. Bonus depreciation on QIPs could generate NOLs, allowing taxpayers to request an immediate tax refund for prior years, bringing another opportunity to generate cash flow in 2021.

Why You Should Act Now

Under TCJA, the bonus depreciation deduction percentage for qualified property will begin to phase out over four years (and sunset completely after Dec. 31, 2026), so taxpayers with real estate property should take advantage of this provision soon. Navigating this process can be complex, so be sure to work with a trusted tax advisor, like those at Doeren Mayhew, to ensure you are properly qualifying property for bonus depreciation to maximize your tax savings.

To learn more about cost segregation studies and whether you can benefit from this significant tax planning opportunity, contact Doeren Mayhew’s dedicated Tax Group today.