By Eddie Price & Amar Patel | Principals – Cost Segregation
After years of 100% bonus depreciation, rates have recently fallen to 80% for 2023 and 60% for 2024, which has motivated some real estate investors to look for additional strategies to offset taxable income. Section 179 of the tax code offers taxpayers the opportunity to fully deduct the cost of certain property as a current year expense instead of capitalizing and depreciating. Taking advantage of Section 179 expensing in combination with the partial disposition deduction could offer additional unexpected relief.
The definition of qualified property under Section 179 expanded in 2017 to include the following real property improvements to nonresidential buildings:
- Roofing
- Fire protection and alarm systems
- Security systems
- HVAC systems
To be eligible, expenditures must be for new improvements that were placed in service after the building was first placed in service. For 2024, the Section 179 deduction limit is $1,220,000 and the phase-out threshold is $3,050,000. The Section 179 deduction is not available to all types of taxpayers and special rules apply to some specific types.
In some cases, the cost of these components may be more appropriately considered a repair & maintenance expense instead of capitalized as an improvement to the building. However, if the expenditure produces a betterment, restoration, or adaptation to the unit of property, then it is required to be capitalized as an improvement. The facts and circumstances associated with the expenditure will determine whether the cost should be capitalized/depreciated, or expensed as a repair.
When an improvement to an existing building is capitalized, any remaining basis in the building’s old components that must be removed can be disposed of. This is known as a partial disposition and results in a deduction in the year the old component is removed. Any associated costs incurred to remove the old component are also deductible. These costs are only deductible if incurred in conjunction with a capital improvement.
KBKG Insight:
However, in the case of Section 179 qualifying real property improvements, there is an additional opportunity to claim not only the partial disposition deduction but also the 179 expense deduction as well. CPAs and building owners can use KBKG’s Partial Disposition Calculator to quantify any building components that have been replaced or demolished in current or prior years to claim significant deductions.
KBKG Case Study:
On January 15, 2021, a taxpayer acquired and placed in service an $8.8 million multi-tenant office building. A cost segregation study prepared at the time of acquisition segregated the major systems and components within the building. In July 2023, building management decided to modernize and upgrade the common areas. In order to receive permits for construction, local codes required a complete replacement of the fire alarm system with a modern fire alarm control panel, smoke detectors, heat detectors, manual pull stations, and notification appliances. The components of the old fire alarm system were either removed or abandoned, which the contractor charged $5,000 for. At the time of disposition, the remaining basis in the old fire alarm system components was $25,000. The cost of the new fire alarm system was $100,000 which must be capitalized as an improvement under the Tangible Property Regulations.
In the year the old components were taken out of service, the taxpayer can deduct the cost of removing the old components as well as take a partial disposition deduction for the remaining basis in the old system. The taxpayer can also deduct the cost of the new fire protection system as a Section 179 expense, as the fire protection improvements are considered qualifying real property improvements under the Section 179 regime.
- Total out-of-pocket cost of the upgrade: $5,000 + $100,000 = $105,000
- Total potential deduction for 2023: $5,000 + $25,000 + $100,000 = $130,000
Conclusion
When the Section 179 expense deduction is combined with the partial disposition deduction, the total deduction exceeds the cost incurred for the new improvement! Even though the bonus rate continues to decline each year, techniques like this offer immediate relief when faced with taxable income.
Action Steps
With a team of engineers and industry-leading experts, KBKG’s proven process has helped clients maximize tax-saving strategies, like cost segregation studies, for years. Contact a KBKG representative today or visit KBKG.com to learn more on how to navigate the nuances and complexities of cost segregation studies.
About the Authors
Eddie Price | Principal – Cost Segregation
Eddie Price is a Principal with KBKG and currently oversees the Southern region and its Texas-based operations. He is a Certified Cost Segregation Professional (CCSP) with the American Society of Cost Segregation Professionals (www.ASCSP.org). With over 40 years of cost segregation experience dating back to the Investment Tax Credit period, Eddie Price is one of the most experienced experts in the industry. Read More.
Amar Patel | Principal – Cost Segregation
Amar spent 15 years at a Big Four accounting firm and one year at Centiv, LLC, focusing on various specialty tax products including Cost Recovery Solutions and Research & Development Tax Credits. In the past 16 years of practice, Amar has become an expert in cost segregation and large fixed asset depreciation reviews for purposes of identifying federal, state, and property tax benefits. Amar earned his bachelor’s degree in Accounting and Finance from The University of Tennessee, Knoxville and is a Georgia-licensed CPA and member of the AICPA. Read More.