Cost Segregation for Commercial Properties

Cost Segregation for Commercial Properties: Offering Tax Benefits for Real Estate Investors

 Real estate investments are popular for numerous reasons, from diversifying a portfolio to earning passive income and building capital. Many investors also benefit from the tax breaks, including deductions.

Cost segregation is often utilized to assist in the acceleration of depreciation for commercial real estate to reduce tax liability and boost cash flow. The process is designed to identify all construction-related costs that can be depreciated over a shorter tax life (typically five, seven and 15 years) than the building (27.5 years for residential buildings and 39 years for non-residential property).

Depreciation is the mechanism used to record the use of an item over its life until the value of the item is zero. It represents the estimated cost associated with the physical deterioration of a property’s condition.

A program sanctioned by the Internal Revenue Service (IRS), cost segregation is used to identify property components that are considered personal property or land improvements under the federal tax code. It categorizes various building components for depreciation as individual assets rather than the entire property. The idea is that most non-structural components of a property deteriorate more quickly than the building itself, allowing them to be depreciated at a faster rate.

The best time to enlist the services of a business experienced in cost segregation studies is during the year a commercial property is constructed, purchased or remodeled. However, such studies can be conducted at any time during property ownership, even if the structure was purchased years ago.

Cost segregation studies consist of four steps:

  1. Feasibility analysis
  2. Collection of property information
  3. Property analysis
  4. Report completion

 

How Does Cost Segregation Benefit Commercial Property Owners and Investors?

For some commercial property owners, the biggest advantage of a cost segregation study is the enhanced cash flow it offers because the funds can be used to purchase more property, reinvest in current properties or pay off their principal building payment. Others use the process to reduce their tax liability, lower local realty-transfer taxes or defer federal and state income taxes.

Completing a cost segregation study can result in savings of more than 20 percent on taxes for the depreciation of those non-structural assets. And, reclassifying eligible assets to a shorter life property often ranges anywhere from ten to 40 percent of the depreciable cost basis.

abstract ceiling and escalator in hall of shopping mall

What Type of Commercial Properties Are Eligible for a Cost Segregation Study?

Most any type of commercial property qualifies for a cost segregation study, although it is not recommended for structures under $200,000. Office buildings and multi-family properties typically consist of more short-life assets than industrial structures, and manufacturing and medical properties often are eligible for five-year deductions.

Commercial properties undergoing a cost segregation study must qualify for depreciation under the United States’ Modified Accelerated Cost Recovery System (MACRS). This process does not apply to commercial structures built, bought or renovated before 1986.

Examples of commercial properties eligible for a cost segregation study include:

  • Shopping centers
  • Chain stores
  • Restaurants
  • Grocery stores
  • Gas stations
  • Hotels/motels
  • Apartment complexes
  • Medical facilities
  • Warehouses
  • Factories
  • Industrial plants

 

How are Commercial Property Assets Categories in Cost Segregation Studies?

Almost all cost segregation studies utilize four main categories: personal property, land improvements, building components and land. There must be a distinction between a building’s structural components and tangible personal property.

Most personal property is depreciated using a five- or seven-year recovery period, while land improvements utilize a 15-year period. A commercial property’s roof and walls are considered part of the structure itself and are classified as 39-year real property. Land assets are not depreciated at all.

 

Personal Property 5- or 7-year depreciation Land Improvements 15-year depreciation
  • Furniture
  • Carpeting
  • Some fixtures
  • Window treatments
  • Partitions
  • Security systems
  • Electrical distribution systems
  • Plumbing
  • HVAC
  • Power boxes
  • Kitchen exhaust systems
  • Sidewalks
  • Walkways
  • Fences
  • Driveways
  • Parking lots
  • Landscaping
  • Docks

Note: These are only examples; this is not a comprehensive list of assets.

 

What Does the Section 179D Tax Deduction Have to Do with Cost Segregation Studies?

An energy tax deduction provided by the U.S. government for commercial buildings, Section 179D can be utilized by building owners who place in service an energy-efficient commercial building property (EECBP) or an energy-efficient commercial building retrofit property (EEBRP). Allowed under Internal Revenue Code (IRC) Section 179D, it was expanded under the Inflation Reduction Act (IRA) of 2022.

Environmental tax breaks concept. Wooden blocks with green taxes icons. Using environmental taxes, carbon tax, environmentally beneficial tax incentives in order to achieve environmental targets.

According to the IRS, the Section 179D deduction is available to owners of qualified commercial buildings and designers of EECBP/EEBRP installed in buildings owned by specified tax-exempt entities, including certain government entities, Indian tribal governments, Alaska Native Corporations and other tax-exempt organizations.

Conducting a Section 179D study along with a cost segregation one has the potential to yield additional tax savings. Section 179D allows for a deduction of up to $1.88 per square foot for properties placed in service before January 1, 2023 and up to $5.00 per square foot for projects placed in service between January 1, 2023 and December 31, 2032.

In 2024, bonus depreciation is 60 percent for equipment placed into service from January 1, 2024, through December 31, 2024. The Section 179 deduction limit for 2024 qualifying equipment purchases is $1,220,000, and the phase-out threshold is $3,050,000.

To qualify for the deduction, commercial properties must meet the following IRS specifications:

EECBP must be installed on or in a building located in the U.S. and within the scope of a specified Reference Standard 90.1 of the American Society of Heating, Refrigerating, and Air Conditioning Engineers (ASHRAE) and the Illuminating Engineering Society of North America. It must be property for which depreciation or amortization is allowable, and installed as part of one of the three areas:

  • The interior lighting systems
  • The heating, cooling, ventilation and hot water systems
  • The building envelope

It must be certified as being installed as part of a plan to reduce the total annual energy and power costs for the above systems by 25 percent or more in comparison to a reference building meeting the minimum requirements of Reference Standard 90.1.

EEBRP must be installed on or in a qualified building as part of one of the three areas:

  • The interior lighting systems;
  • The heating, cooling, ventilation and hot water systems
  • The building envelope

By swiftly accelerating the depreciation deduction expense of real estate acquisitions, property owners can capitalize on the time value of money by maximizing immediate tax savings. Conducting a cost segregation study is not easy, though, and can result in an IRS audit, so compliance is crucial. At 3Sixty Advisors, we offer specialized cost segregation analysis conducted by professionals with expertise in engineering and accounting. Contact us today to learn more!

An Illustrative Guide to Filling Out Form 1120

The number 1.5 million can be used to describe multiple things in the United States. For example, there are 1.5 million faculty at degree-granting postsecondary institutions in the U.S. Roughly 1.5 million Americans have lupus, and approximately that same number of individuals served this great country of ours in Iraq between 2003 and 2011.

In the business world, nearly 1.5 million small businesses officially organized as C corporations employ almost 13 million American workers across various industries. The Internal Revenue Service (IRS) classifies C corporations as independent legal entities owned by their shareholders.

The tax requirements for C corporations are somewhat different from those of other U.S. business types. The profit of a C corporation is taxed twice, once as business income at the entity level and again at the shareholder level when distributed as dividends or realized as capital gains. Corporate income taxes are paid at the corporate income tax rate instead of a personal tax rate.

C corporations must file Form 1120, a process that’s complex for individuals without extensive tax knowledge. In this blog, we’ll cover some of the basics of Form 1120, what types of companies should file it and what information is needed to accurately complete it.

What Exactly Is Form 1120: the Corporation Income Tax Return?

Officially titled the U.S. Corporation Income Tax Return, Form 1120 is utilized by C corporations to figure their income tax liability and report their income, gains, losses, deductions and credits. In addition to paying federal income tax, these businesses may be subject to local and state taxes.

Why do C corporations fill out a separate form from other business entities? One reason is that they are designed to shield business owners from certain tax liabilities. These companies have more than 100 shareholders — or ones outside the U.S.

There are numerous variations of Form 1120, including 1120-S, which S corporations use. Others include:

  • 1120-C: For cooperatives
  • 1120-F: For foreign corporations
  • 1120-H: For condominium management and residential real estate management
  • 1120-L: For life insurance companies
  • 1120-POL: For political organizations

Is Form 1120 for C Corporations or S Corporations?

Unless they are exempt under U.S. Code §501, all domestic corporations are required by the IRS to file Form 1120 annually — even if they do not have taxable income or are in bankruptcy. C corporations include limited liability companies (LLCs) that have elected to be taxed as a corporation. New LLCs utilize IRS Form 8832 to elect how they want to be taxed.

As mentioned earlier in this blog, S corporations file Form 1120-S. Because they do not pay corporate taxes but instead pass their tax liabilities to their individual shareholders, they are categorized as pass-through entities.

What Information Do I Need to Fill Out Form 1120?

One of the reasons Form 1120 can be so “taxing” to complete is that it is six pages long. Another is the amount of information needed to accurately complete it. This financial data consists of details for both operating and non-operating expenses and income.

Other C corporation information used to complete Form 1120 includes:

  • Employer Identification Number (EIN)
  • Date of incorporation
  • Total income and assets
  • Gross receipts
  • Capital gains
  • Tax deductions
  • Interest, dividends and royalties earned
  • Rents
  • Cost of goods sold

When Should Form 1120 Be Filed?

As a guideline, a C corporation must file its Form 1120 by the 15th day of the fourth month after the end of its tax year. Corporations with a fiscal tax year ending June 30 must file by the 15th day of the third month after the end of their tax year.

When expected to owe more than $500 in taxes for the year, C corporations also must pay quarterly estimated tax payments. Such payments are due by the 15th day of the fourth, sixth, ninth and 12th months of the tax year,

If the due date falls on a Saturday, Sunday or a legal holiday, a C corporation can file on the next business day. Businesses that need additional time to file can request a six-month extension using Form 7004. C corporations filing 10 or more returns on or after January 1, 2024 are required to e-file Form 1120. C Corporations failing to file Form 1120 by the due date are subject to penalties based on the time the return is overdue.

Form 1120 Instructions

10 Steps for Filling Out Form 1120 

Once you have gathered the necessary materials, follow these steps to fill out Form 1120:

  1. Download Form 1120.
  2. Enter the necessary corporation information.  
  3. Calculate all taxable income you received during the year. 
  4. Claim any eligible deductions and credits to reduce your tax liability.
  5. Fill out page 2 Schedule C: Dividends, Inclusions and Special Deductions.
  • Dividends and similar income go on Line 23.
  • List any special deductions related to this income on Line 24.
  1. Complete Schedule J – Tax Computation and Payment — on page 3.
  • Part I: Tax Computation
  • Part II: Payments and Refundable Credits
  1. Complete Schedule K —Other Information — on pages 4 and 5.
  • This includes information about the C corporation owners and their investments in other companies.

  1. Complete Schedule L — Balance Sheets per Books — on page 6.
  • Use this schedule to report your balance sheet as found in your C corporation’s books and records.
  1. Complete Schedule M-1 — Reconciliation of Income (Loss) per Books with Income per Return — on page 6.
  • This is used to reconcile your accounting (book) income with your taxable income.
  1. Complete Schedule M-2 — Analysis of Unappropriated Retained Earnings per Books — on page 6.
  • This is used to reconcile your C corporation’s unappropriated retained earnings account as found on the beginning of the year and the end of the year balance sheets. Both balance sheets are listed on Schedule L.

At 3Sixty Advisors Tax Services, we offer proactive tax solutions customized for your business. Our team of tax experts understand the complexities and challenges C corporations encounter when managing your taxes. And, our proprietary technology and focus on compliance ensures that your filing is accurate and conforms to all IRS guidelines. Contact us today to learn more!