The primary mission of The American Society of Cost Segregation Professionals (ASCSP) is to create quality standards for the cost segregation industry. Cost segregation is a valuable tax planning tool allowing for accelerated deductions for investments in real estate. The organization strives to create an awareness of these quality standards to CPAs, other tax specialists, real estate investors, and the general public. To fulfill its mission, the ASCSP will clarify misconceptions within the cost segregation industry. A recent article published in the Forbes Finance Council titled “Cost Segregation Study Provides For Immediate Expense Of Leasehold Improvements” requires correction.
As of the time of this publication, the article states:
After the Tax Cuts and Jobs Act, or TCJA, leasehold improvements are classified as Qualified Improvement Property, or QIP, and must be depreciated using the 39-year straight line method. For example, a real estate investor spends $390,000 to make qualified improvements to an apartment complex. The investor would be allowed under the current system to take a $10,000 deduction against the property’s income to reduce taxable income. Under previous rules, the same improvement would have qualified for immediate expensing.
Treatment of Residential Versus Non-Residential Real Estate
The article provides an example of a $390,000 investment in an apartment complex being depreciated over 39 years. Residential rental property is depreciated over a 27.5-year recovery period using the straight-line method and the mid-month convention whereas nonresidential real property is depreciated over 39 years. Residential rental property includes buildings or structures for which 80 percent or more of the gross rental income is rental income from dwelling units. An apartment complex falls within the definition of residential real estate and should be depreciated over the shorter 27.5-year recovery period.
Qualified Improvement Property
Effective after December 31, 2017, the TCJA consolidated four special asset categories (Qualified Improvement Property (QIP), Qualified Leasehold Improvement Property, Qualified Retail Improvement Property and Qualified Restaurant Improvement Property) into just one category called QIP. While our legislators may have intended to change QIP to a 15-year recovery period making it eligible for 100% bonus depreciation, that change was not made. Although QIP remains depreciable over 39 years, it still may be eligible for the section 179 expense election for those who incur eligible expenditures in their trade or business.
QIP includes any improvements made to a nonresidential building’s interior after the date when the property was first placed in service. However, improvements do not qualify if they are attributable to:
- the enlargement of the building,
- any elevator or escalator or
- the internal structural framework of the building.
In the article, it describes a situation where an investor improves an apartment complex. Since an apartment building is residential real estate, such improvements cannot be QIP. QIP only applies to nonresidential building improvements and as such, would not be eligible for the section 179 expense election.
Expensing Versus 100% Bonus Depreciation
The TCJA increased bonus depreciation to 100 percent for qualified property acquired and placed in service after September 27, 2017 and before January 1, 2023. This generally, applies to depreciable assets with a recovery period of 20 years or less. Both new and used machinery, equipment, furniture, and land improvements now generally qualify, allowing for an immediate tax deduction. Expenditures where a taxpayer has taken 100% bonus depreciation may be subject to depreciation recapture whereas expenses, such as for repair and maintenance, are not.
Depreciation recapture is the gain realized by the sale of depreciable capital property that must be reported as ordinary income for tax purposes. Depreciation recapture is assessed when the sale price of an asset exceeds the tax basis or adjusted cost basis. Thus, a parking lot asset subsequently sold where a taxpayer took 100% bonus depreciation may be subject to depreciation recapture, but the repair and maintenance of a parking lot during the normal course of business would not. It should be clarified that personal property and land improvements identified as a result of a cost segregation study would not be “expensed,” (as written in the heading and body of the article) as in the case of maintenance and repair, but would rather, qualify for 100% bonus depreciation and may potentially be subject to depreciation recapture upon the sale of the property.
While some readers may understand the distinction between an expense and a depreciation deduction, the nuances between these two terms are significant and the article creates a level of confusion that could have easily been avoided.
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The ASCSP was founded in 2006 as the preeminent professional Society for all members of the cost segregation industry. The ASCSP’s goal is to provide its members with education, create and maintain minimum quality standards, and provide a Code of Ethics. The ASCSP provides certifications for its members, the highest of which is a Certified Cost Segregation Professional (CCSP). Becoming a CCSP requires 7 years and 7,000 hours of experience, rigorous testing, and background checks. Please visit the ASCSP website to find an accredited cost segregation professional.