As the extended tax filing period for the 2023 tax year comes to a close, it is time to start planning for the 2024 tax year. For property owners who have incurred significant expenses for newly acquired or constructed properties, cost segregation can be an effective solution. Cost segregation studies identify specific component costs within the overall acquisition or construction costs and assign them a shorter depreciable life for federal tax purposes. This typically involves reclassifying assets to 15, 7, and 5-year property categories instead of the standard 27.5 or 39-year life spans.
In addition to the benefit of shorter depreciable lives, the components identified in a cost segregation study may also qualify for bonus depreciation under §168(k) or §179 expensing under §179(a). These provisions allow for additional deductions in the first year the property is placed into service. However, it is important to note that the allowance for bonus depreciation has gradually decreased from 100% in 2022 to 80% in 2023, and now 60% for assets placed in service in 2024. This phase-out will continue until it sunsets at the end of 2026. As a result, developing strategies to optimize cash flow for real estate investors will become increasingly important.
For the 2023 tax year, §179 limitations were set at $1,160,000, with a phase-out threshold of $2,890,000 for property placed in service. These limits have been increased to $1,220,000 and $3,050,000, respectively, for the 2024 tax year. Items such as roof replacements, HVAC systems, security systems, and qualified improvement property may be eligible for expensing under this provision for tax years after December 31, 2017.
In addition to identifying items eligible for bonus or §179 expensing, a cost segregation study can also help identify items that can be expensed under de minimis expensing or repair and maintenance regulations. Under §1.263(a)-1(f), taxpayers can elect to expense certain items under specific thresholds if they have a written capitalization policy in place at the beginning of the year and also expense those items on their financial statements and other applicable books and records.
Under §1.263(a)-3, taxpayers must capitalize amounts paid for:
- Betterment to a unit of property
- Restoration of a unit of property
- Adaptation to a new or different use
These rules can be complex and rely heavily on facts and circumstances. However, having a cost segregation study performed can highlight circumstances and facts that support the full deductibility of such items in the current year. It is important to note that the deduction must be claimed in the year the expenditure is incurred, making planning and discussions with your tax practitioner all the more important.
Additionally, in light of declining bonus depreciation amounts, opportunities for partial asset dispositions in the case of renovations and remodels have become more important. Within Regulations 1.168(i)-8 and 1.263(a)-1, taxpayers are required to claim a loss on disposed assets to claim removal and demolition costs as currently deductible expenses. The interplay with cost segregation provides even more opportunities to identify and maximize deductions in the current year.
While there have not been any significant changes to tax laws surrounding fixed assets in recent years, it is crucial to discuss any capital outlays with your tax provider to optimize your tax strategy. GBQ is ready and available to help you plan for your success in 2024 and beyond.
