Build or Renovate? A Building Cost Recovery Analysis May Change Your Answer

Posted by Don Warrant on 11/15/18 4:26 PM


Everybody loves that “new building” smell, but renovating an existing building may generate more tax savings. Only a building cost recovery analysis can tell you which way to go.

When a business reaches a point where it needs more space, it’s usually a pretty exciting, often frenetic time for the owners and employees. Whether it’s additional offices for new employees, expanded manufacturing and storage facilities for the business’ products, or a combination of both, many businesses don’t even realize that more space is the answer until long after the need has become severe.

At such a crazy time, the last thing many owners might consider is the tax impact of choosing between renovating an existing building or constructing a new building. That can be an expensive mistake.

The PATH Act made some changes to depreciation rules providing businesses that make improvements to the interior portion of existing buildings with opportunities to recover costs quicker than by constructing a new building.

  • The section 179 expensing election is available to expense up to $500,000 of “qualified real property,” a term that limits this immediate tax deduction to qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property. However, the section 179 expensing election is phased out completely when the costs of eligible property exceeds $2.51 million for the 2016 tax year. The expense limitation and phase-out are adjusted upward for inflation each year.
  • The first year special depreciation allowance, aka “bonus depreciation,” is available for “qualified improvement property” placed in service on or after January 1, 2016. Qualified improvement property is an improvement to the interior of nonresidential real property that is placed in service after the date the building was placed in service. (Certain improvements such as enlargements, escalators/elevators, and internal structural framework are excluded.)

For example, a business with a $10 million budget can use the full budget on constructing a new building or spend $2.5 million to acquire an existing building and $7.5 million on renovations. Although cost segregation can accelerate building cost recovery by assigning property to the property 5-year, 7-year, and 15-year recovery periods, a significant portion of the $10 million construction cost will be assigned to a 39-year recovery period.

If the business acquires and renovates an existing building, in addition to cost segregation of the building acquisition and renovation costs, a portion of the $7.5 million renovation costs will be classified as qualified improvement property and qualified real property. As a result, cost recovery will occur more quickly by acquiring and renovating an existing building than constructing a new building up to a certain cost point. Therefore, it is important to perform a building cost recovery analysis before decisions are made regarding new building construction.

When to Start the Conversation

It is important to raise this issue when you learn that a client is expanding or taking on a new product or process that will require more space or adding employees. When you learn that a client is expanding and needs more space, it’s important to get this information on their radar before decisions are made. Even though construction lead times can be considerable, the decisions that make a difference for tax purposes often happen very early in the process. You don’t want to find out after the fact that a client didn’t perform a building cost recovery analysis before deciding to construct a new building.

Keep in mind that the 50% bonus depreciation is available for property placed in service by December 31, 2017. For qualified improvement property that is placed in service during calendar year 2018 and 2019, the bonus depreciation rates are 40% and 30% respectively. And bonus depreciation will be completely phased out by 2020 (2021 for certain property).

The threshold at which the recovery of costs for new building construction is faster than the recovery of costs to renovate an existing building is based in part, on the price paid for an existing building. The lower the purchase price, the more cost that can be assigned to qualified improvement property and qualified real property to accelerate building cost recovery and tax savings.

Obviously, the acceleration of building cost recovery and tax savings are not the only concern when making the decision, but they can provide a valuable incentive to either reduce construction costs or extend the capital budget.

Need Help with a Building Cost Recovery Analysis?

CSP360 has over 20 years of experience focused on cost segregation services and cost recovery rules. Our cost segregation database makes us the perfect resource to perform a building cost recovery analysis. Contact us to learn more.

Tags: Don Warrant, tax saving opportunities, PATH Act, building cost analysis

IRS PATH Act Rev-Proc Answers Questions About 2015 for Fiscal Year Filers

Posted by Don Warrant on 10/11/16 9:00 AM

Revenue Procedure 2016-48 provides transition rules for PATH Act depreciation changes.

iStock_61137508_SMALL-006016-edited.jpgWe’ve discussed the effect of the PATH Act on real property clients before on this blog. In those discussions, we’ve noted that the PATH Act became law at the end of 2015 and that it retroactively reinstated certain depreciation provisions that had expired at the end of 2014. Even though retroactive reinstatement was widely expected, those provisions were not available during calendar year 2015 impacting fiscal year filers and short tax years beginning and ending in 2015. Therefore, the IRS provided the following guidance in Revenue Procedure 2016-48:

  • Section 4 provides the procedures for claiming or not claiming bonus depreciation while the provision had lapsed, or who elected to not claim bonus depreciation for a class of property.
  • Section 3 provides the procedures to carryover the amount of qualified real property expensed in a prior year that was limited by the taxable income limitation, to a taxable year beginning in 2015.
  • Section 5 provides the procedures for a corporation to elect to forgo bonus depreciation in order to allow tax credits generated before 2006 to be used.

Bonus Depreciation

The PATH Act retroactively reinstated and extended bonus depreciation for qualified property and made changes impacting improvements to commercial buildings placed in service after December 31, 2015 (please see our prior post). Taxpayers with a fiscal tax year that ended in 2015 or with a short tax year that began and ended in 2015 may not have claimed bonus depreciation during the period in which the provision had lapsed, or may have elected to not claim bonus depreciation for a class of property. These taxpayers have the following options:

  1. Amend the tax return to claim bonus depreciation on qualified assets before filing the return for the fiscal tax year ending in 2016;
  2. File Form 3115 under Section 6.01 of Rev. Proc. 2016-29 with a timely filed tax return for the fiscal tax year ending in 2016 or 2017; and
  3. Revoke the election to not claim bonus depreciation for a class of property by filing an amended federal tax return by the earlier of November 11, 2016, or before filing the return for the fiscal tax year ending in 2016.

Section 179 Expensing

The PATH Act reinstated Section 179 expensing of assets in the year placed in service retroactive to January 1, 2015, and made the provision a permanent part of the Tax Code. The Act did retain the limited applicability of this section to commercial real estate to only “qualified real property,” meaning:

  • Qualified leasehold improvement property,
  • Qualified restaurant property, or
  • Qualified retail improvement property.

The permanent provision allows a $500,000 deduction (up from $250,000), but still phases that deduction out dollar-for-dollar to the extent that property placed in service in the year exceeds $2 million. Both the $500,000 and $2 million are indexed for inflation going forward. If a taxpayer makes this election for qualified real property, the entire cost of the qualified real property is taken into consideration for the annual dollar limitation.

Unused deductions can be carried forward to future years. Prior to the PATH Act changes, the carryforward provision as it applied to qualified real property required that any amount carried forward must be treated as depreciable property placed in service on the first day of the last tax year ending in 2014. The Rev. Proc. allows taxpayers to carryover the amount to any taxable year beginning in 2015.

New Options for Commercial Real Estate Owners

The PATH Act has presented commercial real estate owners with new or expanded options that haven’t been available before. Advisors need to make sure that they and their clients are seeing the big picture when it comes to potential tax-saving opportunities. Under the old version of Section 179, benefits for real estate phased out quickly at a low threshold and the carryforward was limited to no later than 2014. As a result, people have gotten accustomed to not considering it in their projections. The new rules allow an indefinite carryforward and also index the deduction amount and the phase-out threshold for inflation. The deduction remains unchanged for 2016, but the phase-out threshold will increase to $2,010,000.

The PATH Act made bonus depreciation available to more property owners, expanding the previous “qualified leasehold improvement property” restriction to a broader “qualified improvement property” category. As a result, commercial real estate owners should realize even more tax savings over the next four years by engaging cost segregation professionals who can segregate costs to acquire and improve commercial buildings.

As always, CSP360 is ready to help. Some of your clients may have a fiscal year situation that was remedied by Rev. Proc. 2016-48. Our commercial real estate focus makes us an ideal back-office support team when it comes to providing specialized, high-quality service to real estate clients. Please contact us for more information about how we can help you better serve current clients and grow your real estate practice.

Tags: Revenue Procedure 2016-48, commercial real estate, PATH Act

Subscribe to Email Updates

real property tax-savings election
263(a) opportunities

Our Latest Resources

Tax slashing hero

cost segregation

CSP360 Deep Dive Program

Latest Posts

Follow Us