Utilizing Cost Segregation and Section 179 Deductions on the same building can be a potent tax savings combination for commercial real estate investors. A cost segregation study creates additional depreciation deductions through asset reclassification, while Section 179 provides deductions for energy efficient building systems. Many folks in the real estate and tax industry are familiar with these strategies, but many are wondering if both incentives can be applied to the same property. The short answer is yes, but first let’s refresh ourselves on each of these tax strategies and learn how one can maximize their tax benefits by utilizing Cost Segregation and 179D.
What is a Cost Segregation Study?
As mentioned, a Cost Segregation Study creates additional depreciation deductions by reclassifying assets over a shorter cost recovery period. Typically, a commercial building is depreciated over 39 years (residential buildings 27.5), yielding a small depreciation deduction over that time. A Cost Segregation Study utilizes engineering and tax legal expertise to determine which assets of a building can qualify for a shorter cost recovery period and Bonus Depreciation. An engineered cost segregation study, as the industry calls it, requires a site assessment to determine property condition and asset value. A perfect example of an asset that qualifies is carpeting. If you buy a building that has carpeting, the value of that carpet is lumped together with the entire building and depreciated 39* years, making that asset “stuck”. A Cost Segregation Study segregates the value of the carpet from the building, reallocates the asset into a shorter cost recovery period (5 or 7 years), and deducts the majority of that value in year one. The carpet, along with other qualified assets, receive the same treatment creating a large year one deduction. And as we know, deductions offset income and therefore, offset taxes owed. This is the brilliance of a Cost Segregation Study.
What is Section 179D?
Section 179D of the tax code provides a dollar per square foot write-off for qualified building systems. The building systems included are envelope, lighting, HVAC and hot water, and the reimbursement rate has recently increased to as much as $5.36 p/sf. To qualify, a third-party engineer must be contracted to conduct an energy study on your building. From there, they will determine if each building system qualifies for the deduction and the recommended amount. For example, a 100,000 square foot building that obtains a certain energy savings threshold will yield a $536,000 deduction (100,000 x 5.36). Buildings that fall below the threshold can still qualify for a $1.00 p/sf deduction. There are also 179 deductions provided for qualified retrofit projects, which look at building renovations.
How do I integrate both incentives?
Utilizing Cost Segregation and 179D is complicated and requires expertise from firms that specialize in each service. In some cases, it is advantageous to utilize one service and not the other. In many cases, how and when a taxpayer should use each service is of the utmost importance and qualification will depend on it. To overcome these challenges advanced planning with your tax advisor and a contracted firm is necessary. Integrating Cost Segregation and 179D requires advanced knowledge of the tax code, building systems, energy modeling, and all corresponding regulations. If done properly, significant deductions can be created, leading to substantial tax savings. If you are interested in learning more about these services, please contact the ATS team below.
