The Coronavirus Aid, Relief, and Economic Security (CARES) Act of March of 2020 provided a monumental tax change for real estate owners and investors not previously available. Among other tax benefits, it laid out very important changes to Qualified Improvement Property (QIP), which is generally leasehold and other interior improvements to a nonresidential building after being placed in service. The Tax Cuts and Jobs Act (TCJA) of 2017 contained a drafting error that was fixed by the CARES Act. The omission was twofold: First, QIP had to be depreciated over 39 years, and second, QIP did not qualify for immediate expensing or bonus depreciation because of the TJCA’s limit to classes of assets with lives shorter than 20 years. The CARES Act fixes this by changing the depreciable life of QIP to 15 years AND allowing for 100% bonus depreciation in the first year. In addition, these changes can be made retroactively to tax years 2018.
What does this mean for you? If you have made any significant QIP improvements to your properties since 2018 those items can be fully deductible and even create net operating losses that can be carried back and forward. Where does a cost segregation come into play? If you have purchased a commercial property in 2018 or later, you can have an engineer prepare a cost segregation study to specifically identify asset classes with shorter depreciable lives to create larger tax deductions. Essentially, cost segregation allows you to accelerate your tax write offs instead of taking small amounts of depreciation each year. Commercial property has a 39 year life and residential is 27.5 years. Allocating interior equipment and improvements to 15 year property can greatly increase your tax deductions in coming years.
Cost segregations and the bonus depreciation allowed by the CARES Act can also benefit tenants such as restauranteurs and retailers who do large renovations or build out spaces. If the tenant is paying for the cost segregation or paying for the improvements, they are entitled to the tax write off. Take for example a restaurant that did a renovation of their leased property in 2018. If they spent $100,000 on the renovation, they can amend their 2018 return and take 100% of that as a write off against 2018 and 2019 revenue. This is a huge opportunity for owners and tenants in this situation who where forced to closed due to COVID-19.
It is important to weigh the benefits against the costs of a cost segregation study. Do you need the tax write offs now to increase cash flow or offset income from other properties owned by the same entity? If you don’t need the write offs, then the study – which is often times expensive – is not your best option. Another important note on this subject is that when you sell the property there is a 25% depreciation recapture tax on the depreciation you have taken, in addition to a capital gains tax. Real estate owners can avoid both of these taxes using a 1031 exchange. Where that can’t be done, there’s also partial asset disposition which allows you to allocate less value to the personal property at the sale to get around the depreciation recapture tax.
Not sure if you should consider it? Discuss your options with us and get informed advice. You can reach me at firstname.lastname@example.org or by phone at (561) 701-4623. Now may be a better time than ever.