When manufacturers purchase, construct, or upgrade their facilities, they make significant investments. However, these costs typically cannot be deducted right away for tax purposes. Fortunately, there is an alternative that can help speed up depreciation deductions: a cost segregation study.
Depreciation 101
For assets with a useful life of more than one year, you generally must depreciate the cost over a period of years. The depreciation periods differ depending on the type and class of the property. For example, tangible personal property generally can be depreciated over three, five or seven years (depending on the specific asset class) — with larger deductions in earlier years if the Modified Accelerated Cost Recovery System (MACRS) is followed. And qualified improvement property (QIP) and depreciable land improvements can be depreciated over 15 years. But it takes almost four decades — 39 years to be exact — to depreciate the cost of a commercial building, such as a manufacturing facility.
There may, however, be a more tax-efficient way to claim depreciation deductions for your facility. Portions of a commercial building may be treated like tangible personal property if they relate solely to the equipment used in the building. Traditionally, this may include the following common components:
- Electrical and HVAC systems,
- Roofing,
- Plumbing fixtures, and
- Flooring and carpeting.
There’s more leeway in manufacturing than most other industries. The expanded list of potential components includes conveyer belts, service bay doors, certain workstations, trash enclosures and robotic machinery.
How a Cost Segregation Study Can Help
Because the depreciation periods for various components depend on the building’s exact use, manufacturers often rely on professional experts to provide a cost segregation study. In a nutshell, a cost segregation study combines accounting and engineering techniques to identify building costs that are properly allocable to tangible personal property rather than real property. Although the relative costs and benefits of a cost segregation study will depend on your particular facts and circumstances, it can be a valuable investment.
It may allow you to accelerate depreciation deductions on certain items, thereby reducing taxes and boosting cash flow. In addition to identifying building components that qualify as tangible personal property, a cost segregation study can identify QIP and land improvements that also can be depreciated more quickly.
2 Big Tax Breaks
A cost segregation study can be particularly powerful if it allows you to take advantage of the two biggest depreciation-related tax breaks: Section 179 expensing and first-year bonus depreciation.
Under Sec. 179 of the tax code, a manufacturer can expense up to $1.22 million of the cost of qualified property placed in service during 2024. (This amount is annually indexed for inflation.) Examples of building components that may be eligible include roofs, HVAC systems, fire protection, and security systems that meet certain requirements.
However, Sec. 179 expensing can’t exceed the amount of your business income for the year. In addition, the expense deduction is reduced on a dollar-for-dollar basis when asset acquisitions for 2024 exceed $3.05 million (also annually indexed for inflation).
If eligible property expenses for the year are more than what can be deducted under Sec. 179 expensing, manufacturers can claim first-year bonus depreciation. The bonus depreciation percentage for 2024 is 60%. This percentage is scheduled to go down to 40% for 2025 and 20% for 2026, after which bonus depreciation will expire if there’s no legislation to extend it.
Any remaining amount after Sec. 179 expensing and first-year bonus depreciation can be written off over the applicable depreciation period.
Is Cost Segregation Right for You?
The initial investment in a manufacturing facility is substantial and the traditional depreciation process can be slow, which makes a cost segregation study a viable solution. Accelerating tax deductions and enhancing cash flow is certainly one way to offset a large investment. While the relative costs and benefits of a cost segregation study will vary based on your specific situation, it often proves to be a valuable financial strategy.
Curious if you’re a good candidate for a study? Connect with CSH to find out.
