It usually takes a long time—39 years, to be exact—to recoup the full cost of a business building through depreciation deductions. But there’s a way to secure faster tax benefits.
Strategy: Separate building components for tax purposes. As long as you meet certain requirements, you may write off the cost of some building components in only five or seven years. And your business doesn’t have to apply to the IRS for a change in its accounting method.
Best of all, the components may qualify for “bonus depreciation” under the latest tax rules. The new 2010 Tax Relief Act authorizes 100% bonus depreciation for qualified property placed in service in 2011.
The percentage will be cut in half to 50% for qualified property placed in service in 2012 (see box below).
Instead of a taking five or seven years to deduct the cost of components, you might write off the entire cost in just one year!
That’s not to say that the IRS gives taxpayers carte blanche to divvy up parts of buildings. It doesn’t. The IRS often challenges “cost-segregation studies” that have been used to justify faster write-offs. But you can still pass muster based on the latest guidance.
Here’s the whole story: Under the Modified Accelerated Cost Recovery System (MACRS), the cost recovery period for a commercial building is 39 years. On the other hand, personal property may be written off over five years if the property has a useful life between four and 10 years. A seven-year period may be used for property with a useful life between 11 and 15 years.
Generally, IRS regulations define “personal property” as tangible depreciable property (other than buildings and their structural components) including property used in specialized industries, such as transportation and communications, and several other specialized types of property. (IRS regulation 1.48-1(c))
Several recent court cases have held that parts of a commercial building may be treated like personal property if they relate only to the equipment used in a business located in the building instead of maintenance or operation of the building. These typically include components such as special electrical systems, plumbing systems in restaurant kitchens and removable carpeting.
Example: Your restaurant installs decorative light fixtures costing $50,000. Normally, the fixtures would qualify as seven-year property, so you would be able deduct $7,145 in the first year under the MACRS tables ($50,000 x 14.29%). Thanks to 100% bonus depreciation, however, the entire $50,000 cost can be deducted in 2011.
The use of components often depends on the particular use of a building. Thus, taxpayers may commission experts to provide cost-segregation studies breaking down the write-off periods for components. A few years back, the IRS issued a 115-page Audit Techniques Guide (ATG) to help its agents examine cost-segregation studies.
No secrets: The IRS isn’t hiding anything up its sleeve. Anyone can check out the ATG at http://tinyurl.com/ATGguide.
Tip: Hire an expert for your specific industry. Depending on the results, you might reclassify certain components and file amended returns for the appropriate years.
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