United States

A cost-segregation study can mean significant permanent tax savings


In the aftermath of the federal tax overhaul of 2017, an increased emphasis on tax planning and timing items has emerged. Beginning in 2018, the top corporate tax rate has been reduced from 35 percent to 21 percent, and pass-through entity rates that qualify for the new full 20 percent deduction have been reduced from the top rate of 39.6 percent to 29.6 percent. Simply put, tax deductions were worth more in 2017 than they will be in future periods.

Perhaps the most common timing item for companies is fixed-asset depreciation. Generally accepted accounting principles and tax rules typically differ on fixed asset depreciation lives and the speed at which those investments are recovered through expenses or tax deductions. With a consistent tax rate every year, these depreciation timing differences result in the exact same cash taxes being paid over a period of time until the asset has been fully depreciated; the tax is merely paid now or at some later date.

But there is a way to accelerate depreciation into 2017 to take advantage of tax deductions at that period’s more favorable tax rates. 

The cost-segregation study

A cost-segregation study identifies and carves out personal property assets that have originally been combined with real property assets. A common fact pattern occurs when a company buys a $500,000 plot of land and constructs a $5 million building on it. So at the time the building is placed into service, the company records two line items on its fixed asset records: land ($500,000) and building ($5 million).

Land cannot be depreciated and the cost of the building is depreciated over 39 years using straight-line depreciation. But what if the company could separate out $1 million of costs from the building and categorize them into depreciable lives of five, seven or 15 years via a cost-segregation study? These costs could be deducted over a much shorter period of time and could result in significant permanent tax savings on a 2017 tax return at higher tax rates.  

This cost-segregation approach is commonly used in special concrete foundation pits used to support heavy equipment; in utilities such as gas, water and electric that support specific equipment; and in parking lots and other land improvements such as sidewalks and landscaping.

Original buildings, or expansions placed into service in the past 20 years, are prime candidates for a cost-segregation study and usually a tax fixed-asset report is the only information needed to scope the potential benefit.

Window is closing on this tax planning opportunity

Companies should review their tax fixed-asset reports and act fast to take advantage of this tax planning opportunity with the filing of their 2017 tax returns. Changes to tax depreciation asset categories should be reported on the Form 3115 using an automatic method change number 7. Companies have until the extended due dates of their tax returns to file the Form 3115 (Sept. 15 for calendar-year pass-through companies; and Oct. 15 for calendar-year C corporations). Companies with valid extensions that have already filed tax returns for 2017 are able to amend these returns by the extended due date.

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