May, 2003 Tax Tip
Maximizing Your Depreciation Deduction
When we look at a building, we normally assume that it must be depreciated over 27˝ or 39 years, depending upon whether it is residential or commercial. This is not necessarily true. Sometimes, much of what we think is a building depreciable over 27˝ or 39 years can actually be depreciated faster.
It’s natural to think of all the computer cables, electric wiring, concrete work and similar items that are normal “components” of a building as very long lived assets, but they may not be.
Many court cases and IRS rulings have allowed building owners the opportunity to reclassify certain costs to 7-year or possibly 5-year assets rather than 27˝ or 39-year assets. These cases and rulings have taken more of a functional use approach in determining the proper depreciable life of assets.
The debt service on the loan to acquire the property is a substantial cash drain, so any tax benefits, including faster write-off of the property's cost, would be most welcome. As a simple example of how this might work, any component building costs incurred to support a computer or telephone system (e.g. wiring, etc.) can very likely justify a 5 or 7 year life, the life of the related computer or telephone system.
Tax legislation passed after September 11, 2001 provides for an immediate expensing of 30% of the cost of qualifying property (which does not include 27˝ or 39 year assets). In general, qualifying property is original use property purchased between September 10, 2001 and September 11, 2004 and put in service by January 1, 2005. Therefore, reclassifying 27˝ or 39-year property to 7year or 5 year property has tremendous potential savings. However, even if the property is purchased after September 11, 2004 or placed in service after January 1, 2005, you can still benefit from the faster depreciation of 5 or 7 year components discussed in the preceding paragraphs.
Even if the building is an older building the IRS has a procedure that will allow you to change your method of accounting for the asset depreciation. Because of this, “segregating” costs based on asset use makes sense for any real property purchased or built after 1987.
In the past, the effects of a change like this would have to be reported over 4 years. However, recent Revenue Procedures allow certain taxpayers to take the full effect of these type changes in the year of the change.
To summarize, you may very well may be able to greatly accelerate your depreciation on longer lived assets if you properly segregate the costs of those assets based on their true uses. Of course, you must have records to support the cost of the components that can be advantageously segregated. The savings can be substantial, but you must act soon to realize the full potential of the savings.
I would be happy to discuss with you the possibilities of segregating the costs of a commercial or rental residential property you own in order to take advantage of these tax breaks.
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