For years, taxpayers have been able to take advantage of cost segregation and the Section 179D Energy Efficient Commercial Building Deduction (Section 179D) studies. These studies help to recover costs from facility purchases or construction while also reducing their tax liabilities.
Cost Segregation Analyses
A cost segregation study is a strategic tax planning tool that allows property owners to increase their cash flows through acceleration of depreciation deductions and deferral of tax payments. The process involves identifying and segregating a portion of a building’s cost basis into shorter lived assets. The short-lived assets, 20-years and under, are generally eligible for bonus deprecation. The ideal timeframe in which to conduct a cost segregation analysis is within the same year a building is constructed or an existing facility is purchased. Assets placed in service in prior years are also good candidates for cost segregation studies as past accelerated depreciation can be pulled into the current filing year via a Form 3115 – no amended return required.
From the Tax Cut and Jobs Act (TCJA) of 2017, bonus depreciation was increased from 50% to 100%. This means that the short-lived assets identified in the cost segregation study could be completely expensed in the first year of service. The TCJA also stipulated that acquired assets could qualify for bonus. Prior to that only newly constructed assets qualified for bonus depreciation. The Inflation Reduction Act (IRA) reduced bonus to 80% for 2023, 60% in 2024, 40% in 2025, 20% in 2026 and no bonus in 2027 and beyond
Section 179D Updates from the Inflation Reduction Act (IRA)
The Section 179D tax deduction allows energy-efficient building improvements or new building construction to be eligible for a tax deduction of up to $5 per square foot. This deduction is available to taxpayers who build new assets or make upgrades to their lighting, insulation, or heating, ventilation, and air conditioning (HVAC) systems. Additionally, architects and engineers who design energy-efficient systems for government-owned buildings could be eligible to take this deduction.
Section 179D Changes:
- Maximum deduction increased from $1.88 per square foot to $5.36 per square foot for buildings placed into service beginning after 2022.
- Nonprofit entities, government institutions, and tribal landowners can now allocate the Section 179D deduction to eligible designers.
- The tax deduction is now available after additional investments were made in subsequent tax years.
Selecting Reputable Providers
With these changes, many new organizations are attempting to provide Section 179D services. It may seem beneficial to work with a service provider with the lowest rates or a convenient one in your area. However, it is important to consider the consequences of an incorrectly calculated benefit or ill-prepared tax document.
Investing the energy to learn about a service provider’s expertise and experience could save you time, money and headaches.
Cost Segregation Service Provider Considerations
- Approach: An engineering-based approach is considered the most accurate approach to cost segregation studies. Simply filling out an online form, survey or letter leaves more room for errors, resulting in inaccurate results.
- Physical Site Inspection: While a site inspection is not required, the Internal Revenue Service (IRS) could view the lack of one as a potential red flag when reviewing the study.
- Documentation for Proposal: Some service providers often only ask for the property cost and address to produce a proposal. A more skillful proposal would include closing documents and appraisal drawings to gain a better understanding of the subject property, as well as how to maximize potential benefits in cost segregation and other areas, such as Section 179D.
- Other Tax-Related Services: Some providers may be able to provide Form 3115 completion services and a depreciation schedule in addition to cost segregation services.
- Statistical Sample Study: A statistical sample study can save you from paying high fees for doing a cost segregation study on similar properties. This study requires a sampling analysis of subject properties that is separate from the cost segregation analysis.
- Review Construction Cost Documents: Certain service providers put this task on the client and prefer only to manage the analysis. Premier providers will include this step in their study to reconcile the construction cost documents back to your budget and establish a final cost segregation balance. This is done so there is no gap between costs and budget.
Section 179D Service Provider Considerations
- Length of Providing Section 179D Services: Determine how long the provider has been conducting Section 179D studies for proof of a quality, defensible product.
- Staff CPAs: Having CPAs on staff to prepare returns or file forms can better determine exactly how you can benefit.
- Audit Defense: The service provider should be able to conduct an audit to defend their work, which aligns with the audit technique guide (ATG).
- Fee Structure: If the provider has contingent billing, it can be a reportable transaction, which is prohibited in IRS Circular 230.
- In-House Modeling Team: Having an in-house specialist conduct your energy modeler helps protect sensitive data that certain providers could be sending to a third party.
- Tax-Exempt Projects: When conducting projects for tax-exempt building owners, having a firm that will directly work with the building owner is incredibly beneficial when determining eligibility for this complicated incentive.
- Professional Engineers on Staff: A Section 179D inspection must be performed by a professional engineer or contractor licensed in the jurisdiction of the building. With certain exceptions made due to COVID-19 travel restrictions, a virtual inspection, or one not performed under the direction of a professional engineer, does not meet the requirements set out by the IRS.
Guiding You Forward
The Cherry Bekaert Tax Credits & Incentives team proudly holds ourselves to the standards listed above that make us a reputable cost segregation and Section 179D provider. We have a robust team with extensive knowledge in these areas here to answer any questions you may have about these services.
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