Don't Miss the Added Tax Depreciation Deadline

June 2018

TAX_CostSeg_webpageheader.jpg

By Grant Keppel and Doug Curtis
 

October 15, 2018 Filings are the last time to receive maximum savings

With the passage of 2017 tax reform legislation, C corporations can receive a one-time permanent tax benefit for any deductions they can accelerate into the 2017 tax year, due to the shift in tax rates from 35 percent in 2017 to the new corporate tax rate of 21 percent beginning in 2018. Corporations who have extended their income tax returns for 2017 have until October 15, 2018, to take advantage of this one-time arbitrage of up to 14 percent.
 

Why Now? Permanent Benefit to Accelerating Tax Depreciation

Many public companies and others have typically viewed any shift in income tax depreciation to be temporary and considered accelerating this type of deduction as not particularly lucrative in terms of shareholder value or share price. Often, they are more interested in permanent benefits they believe more fruitful for their overall tax position. However, corporations that own commercial real estate and have not performed a cost segregation study have reason to reconsider prior to filing their 2017 taxes—accelerating their tax depreciation may lead to significant benefits given the right set of circumstances.

Typically, a non-residential real property asset in service in the first year of the asset’s life will provide the company a depreciation deduction anywhere from .107 percent to as high as 2.461 percent (depending on the month in service) of the asset’s depreciable basis. However, additional assets hidden or imbedded within that real estate asset can be identified and carved out to assets with five, seven or 15-year recovery periods. Those first-year percentages can range from 5 percent to as high as 20 percent on the asset’s depreciable cost. Depending on the dollar shift of qualifying assets, the percentages can be nearly tenfold if compared to assets remaining in the 39-year building asset classification.

But how can companies maximize the benefit?

Cost segregation studies are a tax planning technique that examine commercial real estate assets to identify contained assets that could have tax recovery lives much shorter than the traditional non-residential or residential assets. Below, we explore some case studies that showcase how a cost segregation study performed for tax year 2017 can help companies ensure they receive the largest depreciation savings possible.
 
Background: A restaurant operator owns a portfolio of 50 free-standing restaurants constructed between 2004-2017 and holds all its real estate in a C corporation. The average new construction cost for each location was $1,500,000. The operator through the years carried the real estate assets’ tax depreciation schedules over the traditional 39-year recovery period. It also took advantage of the Qualified Restaurant Property rules (which includes 15-year straight line lives) for the allowed years. The owner also extended their 2017 corporate return.
In 2018, the restaurant operator engaged a firm to assist with a fixed asset review and to conduct a cost segregation study on all 50 restaurants. Upon completion of the study, the company achieved acceleration of over $11,000,000 in additional depreciation into tax year 2017.

Impact: The company permanently saved approximately $1,600,000. This example showcases the impact of the one-year arbitrage in tax rates shifting from 35 percent to 21 percent. If the operator waited to do this study in the 2018 tax year, they would have received 14 percent less tax cash flow.
 
Background: A retail chain owns 20 freestanding locations constructed between 2009-2015 at an average cost of $1,000,000. The company owns their real estate portfolio inside a C corporation and extended their income tax returns for 2017. Prior to conducting their fixed asset review, they carried their real estate assets over the 39-year recovery period.

After conducting their own cost segregation study, averaging a reallocation of 20 percent of the cost basis between five and 15-year recovery lives, with the balance remaining at the 39-year recovery life, the company accelerated approximately $2,900,000 in additional depreciation for the 2017 tax year.

Impact: The impact of the one-time permanent savings was over $400,000. Similar to the above case, if the retailer waited until tax year 2018 to conduct their cost segregation study, they would have saved 14 percent less, given the corporate tax rate change included in the TCJA.
 

Benefits to Pass-through Entities

This tax rate arbitrage can also benefit owners or operators of real estate held within pass-through entities such as S corporations, limited liability companies, partnerships or sole proprietorships but at a lower 2.6 percent permanent benefit, given the TCJA’s reduction of personal tax rates from a high of 39.6 percent to the maximum rate of 37 percent beginning in 2018. The window of opportunity for pass-through entities is shorter, as the extended income tax return deadline for pass-through entities is September 15, 2018.
 
Background: A landlord owns a portfolio of twenty class “A” office buildings acquired between 2005-2014 at an average acquisition cost per location of $10,000,000. The landlord carried the real estate assets over the traditional 39-year recovery period. The landlord held all their real estate inside a C corporation and extended their 2017 corporate return.

During 2018, the company engaged a firm to assist with a fixed asset review and conducted a cost segregation study on all 20 office buildings. Upon completion of the study, the company achieved acceleration of over $18,000,000 in additional depreciation into the tax year 2017.

Impact: The company permanently saved approximately $2,500,000. This showcases the impact of the one-year arbitrage in tax rates shifting from 35 percent to 21 percent. If the landlord had held the real estate in a pass-through entity, and assuming the highest individual tax bracket in 2017, the one-year arbitrage would have been approximately $468,000 (39.6 percent vs. 37 percent).
 

Act Now to Meet October 15th Deadline

For companies with extensions on 2017 income tax filings, now is the time to consider a cost segregation study that could lead to significant savings. The average duration of a professionally completed study is between 30 to 60 days, meaning there is still time to reap the maximum benefits of this one-time added tax depreciation.