Withum has previously published various articles about cost segregation – what it is, how it works, and the IRS’s view on cost segregation – but what about the timing of a study?
To take advantage of the time value of money, the cost segregation study should be completed in the year the building is placed in service. However, a study can be performed on any property as far back as 1987 if there are improperly classified assets on the books. Improperly classified assets refer to the purchase price of a property classified as 39-year property or 27.5-year property in total upon purchase or construction. The IRS allows restatement and reclassification of these assets without amending prior tax returns. The understated depreciation expense can be brought forward for any asset that has been improperly calculated in previous years into a current tax return.
Example: An asset was purchased in 2010 for $100,000 and assigned a 39-year tax life. The asset has been depreciated for the last 8 years, or approximately 20%, giving the asset a remaining basis of approximately $80,000. A cost segregation study is performed, allocating that original $100,000 purchase price to 39-year property, 15-year property, 7-year property and 5-year property, resulting in catch-up depreciation for the 5- and 7-year property, which are fully depreciated, and the 15-year property. The IRS allows corrections to the life of the original asset without being penalized or requiring an amended return. A Form 3115 is filed with the current year tax return, which will reflect an IRC Section 481a favorable adjustment to taxable income.
If a taxpayer is projecting an increase in taxable income in the future and holds real estate that may provide an accelerated tax benefit from a cost segregation study, consider this a tax planning opportunity.