Cost Segregation and Opportunity Zones – A Tax Cuts and Jobs Act Impact

Businesses that acquire, construct or perform capital improvements to buildings could find additional deduction benefits through a cost segregation study. It is a strategic tool to accelerate depreciation expense. Combining tax accounting and engineering techniques allows the acceleration of certain depreciation costs, therefore reducing tax costs and boosting cash flow. The potential benefits are even greater now with the impact of depreciation breaks under the Tax Cuts and Jobs Act (TCJA).

Structural elements, such as plumbing, wiring, and HVAC, are depreciated over 39 years for commercial buildings, 27 ½ years for residential. Personal property, such as furniture, equipment, fixtures, removable flooring, cabinetry, and window treatments are eligible for an accelerated depreciation of five or seven years. Land improvements in the way of fences, lighting, parking lots, sidewalks and landscaping are able to be depreciated over 15 years.

Cost segregation studies have the potential to uncover instances where a business may have classified personal property as real property, overlooking the opportunity to accelerate depreciation deduction benefits. This misclassification often occurs when structural improvements for a specific business purpose, such as in the case of reinforced flooring or wiring for a machine required for specific business operations, are classified as real property when it could qualify as personal.

Certain property types may be treated differently for income tax and property tax purposes. Be sure to work with a qualified tax advisor to eliminate confusion in the classification of your investments and improvements and to avoid being taxed twice.

Impact of TCJA on Cost Segregation

Last year’s TCJA enhances certain depreciation-related tax breaks, which in turn may enhance the benefits of a cost segregation study. TCJA permanently increased limits on Section 179 expensing allowing immediate deduction of the entire cost of qualifying equipment or other fixed assets up to specified thresholds.

In addition, it temporarily increased first-year bonus depreciation to 100%, where it previously was at 50%. Converting what would be a 39-year asset to a classification eligible for 100% write-off in the year of acquisition delivers huge tax savings.

Look-back Cost Segregation Study

If your business invested in depreciable buildings or improvements in previous years, you have an opportunity take advantage of a “look-back” cost segregation study. This allows you to claim missed deductions back to 1987.

A one-time “catch-up” deduction can be claimed on your current year return with no need to amend returns from previous years.

Opportunity Zones

Opportunity Zones are tracts created to increase investment by investors in specific low-income communities to boost economic development. Under the program, investors can defer federal taxes on any recent capital gains until December 31, 2026, reduce their tax payment by up to 15%, and pay as little as zero taxes on potential profits from an Opportunity Fund if the investment is held for 10 years.

Arizona’s Opportunity Zone nominations were submitted on March 21, 2018 and approved by the U.S. Treasury Department on April 9, 2018, making Arizona one of the first states in the nation to have its zones officially designated.

View Arizona’s Opportunity Zones

Investing within an Opportunity Zone comes with tax benefits to the investors, while providing economic and growth opportunity to the associated communities. Benefits to investors include:

  • Deferred tax on the initial realized capital gain is deferred and reduced depending on the length of time the investment is held.
  • If investment is held for 10 years, capital gains made on the investment will not be taxed.

Both cost segregation studies and opportunity zone investments can yield considerable benefits, but they aren’t right in every situation. Contact your Schmidt Westergard tax advisor to determine if either is right for you.

Read more about tax law changes and the Tax Cuts and Jobs Act:

Tax Reform Update: Meals and Entertainment Deductions

Tax Cuts and Jobs Act: 2018 Federal Tax Law Changes for Pass-Throughs