When manufacturers buy, build, or improve their facilities, they make a significant investment. However, these expenses are often not immediately tax deductible. Fortunately, there may be another way to expedite your depreciation deductions: a cost segregation study.
Understanding Depreciation
For assets with a useful life of more than a year, the cost must be depreciated over a period of years. The depreciation periods vary according to the type and class of the property. For example, tangible personal property is usually depreciated over three, five, or seven years (depending on the asset class), with larger deductions in earlier years if the Modified Accelerated Cost Recovery System (MACRS) is used. Qualified improvement property (QIP) and depreciable land improvements can be depreciated over a 15-year period. However, it takes nearly four decades—39 years to be precise—to depreciate the cost of a commercial property, such as a manufacturing facility.
However, there may be a more tax-efficient approach to claiming your facility’s depreciation deductions. Portions of a commercial structure may be classified as tangible personal property if they relate solely to the building’s equipment. This could include the following common components:
- Electrical and HVAC systems
- Roofing
- Plumbing fixtures
- Flooring and carpeting
Manufacturing allows for greater flexibility than most other businesses. The expanded list of potential components includes conveyor belts, service bay doors, specialized workstations, trash enclosures, and robotic machinery.
How a Cost Segregation Study Can Help
Because the depreciation periods for different components vary depending on the building’s specific use, manufacturers frequently rely on professional experts to conduct a cost segregation study. In short, a cost segregation study uses accounting and engineering methodologies to identify building expenses that should be allocated to tangible personal property rather than real property. Although the relative costs and benefits of a cost segregation study will vary based on your specific facts and circumstances, it can be a worthwhile investment.
It may allow you to accelerate depreciation deductions for particular items, lowering taxes and increasing cash flow. In addition to finding building components that qualify as tangible personal property, a cost segregation study can identify QIP and land improvements that can be depreciated sooner.
Two Big Tax Breaks
A cost segregation study can be especially effective if it allows you to take advantage of the two most significant 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 in 2024. (This amount is adjusted annually for inflation.) Roofs, HVAC systems, fire prevention, and security systems that meet specified criteria are examples of potentially eligible building components.
However, Sec. 179 expensing cannot exceed the amount of your business’s income for the year. Furthermore, when asset acquisitions for 2024 reach $3.05 million, the expense deduction is lowered dollar for dollar (also annually indexed for inflation).
If qualified property expenses for the year exceed the amount that can be deducted under Sec. 179 expensing, manufacturers can claim first-year bonus depreciation. The bonus depreciation percentage in 2024 is 60%. This proportion is set to fall to 40% in 2025 and 20% in 2026, at which point bonus depreciation will expire unless legislation is passed to continue it.
Any residual balance after Sec. 179 expensing and first-year bonus depreciation can be written off over the corresponding depreciation period.
Weighing the Costs and Advantages of a Cost Segregation Study
The relative costs and benefits of a cost segregation study will vary depending on your specific facts and circumstances, but it can be a worthwhile investment. Contact us for further information.
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