Real estate is often the largest asset for closely held businesses, and owners should consider opportunities for maximizing income tax depreciation deductions on property owned. To determine possible tax savings, closely held business owners should examine the following areas: Separating improvements from land, turning land into a deductible asset and separating personal property from buildings.
Separating improvements from land: The entire cost of acquiring real estate may not be depreciable. For example, the cost of improvements to land is depreciable, but the cost of the land itself is not. With that in mind, it is advantageous to identify and document the portion of the overall acquisition cost that can be allocated to improvements at the time the real estate is acquired.
When purchasing a property in need of improvements, one approach would be to secure the services of a qualified real estate appraiser to make an allocation between land and improvements. You can also perform this analysis yourself if you or someone in your company has valuation expertise, but in either case, ensure the techniques utilized are respected by the applicable tax laws.
Turning land into a deductible asset: Even though land isn’t depreciable, there are ways to obtain deductions that provide a similar tax benefit for land costs. For example, a long-term lease rather than a purchase may be a viable option. If the company leases the land, the rents paid under that “ground lease” may be deductible. Another option may be the acquisition of an interest in land known as an “estate-for-years,” which allows you to amortize the cost of the land over a specified period of time.
Separating personal property from buildings: Most business buildings must be depreciated over a period of 39 years. This period includes a somewhat more favorable treatment for residential rental real estate (27.5 years) and for certain other types of buildings or building improvements. Meanwhile, most personal property (furniture, equipment, etc.) and land improvements are depreciable over considerably shorter periods of time, typically 5, 7, or 15 years. It is worth noting that new personal property is eligible for additional first-year depreciation (bonus depreciation) equal to 50 percent of the cost of the asset. Bonus depreciation has not yet been extended for the 2015 tax year but is included in the extenders package making its way through congress.
When focusing on buildings or building improvements, it is important to keep in mind that only certain improvements qualify for bonus depreciation. If a specific item is classified as personal property rather than as a part of a building, the depreciation deductions for that item will be available sooner and, in economic terms, have a greater “present value” to the property owner. Therefore, it is important to take steps to identify and document the items that are personal property and the items that are building components. This process is known as Cost Segregation. This should ideally be facilitated at the time the real estate is constructed or acquired. However, in cases where the owner overlooked this particular tax planning strategy at the time of acquisition, a Cost Segregation Study can be completed several years after acquisition. In such an instance, your tax advisor can work with you to “catch up” on any missed depreciation in the current tax year.
For some items, the distinction between what qualifies as personal property and what should be included as a building part follows conventional logic and common sense. For example, an ordinary chair would be personal property while a weight-bearing brick wall is part of a building. However, for many items, including lighting fixtures, signs, floor coverings, wall coverings, plumbing, electrical systems and heating and cooling systems, the distinctions are governed by tax rules that can be complex. These distinctions can involve projections as to the future use of the items and may even necessitate consultation with engineers or other construction experts. After the personal property and building items are separately identified, they must be separately valued through industry standard estimation techniques, a breakdown of construction costs or both.
How We Help
If you are involved in the ownership of a closely held business and would like to discuss depreciation options found in real estate and property ownership, Elliott Davis Decosimo has a team of experienced professionals who can walk you through the particulars. We have the expertise to an answer your questions concerning planning techniques and issues related to implementation. For example, our closely held business team members can help your business identify which individuals or entities qualify as “unrelated” and work with you to determine the practicality of an estate-for-years as applied to a specific acquisition. Contact your Elliott Davis Decosimo or click here.