Cost Segregation & Recapture Taxes

Cost Segregation & Recapture Taxes

See also Cost Segregation Studies

Cost segregation studies have become a popular way for commercial property owners and qualifying leaseholders to realize an immediate tax savings. Whether its new construction, improvements or the owner has recently acquired the property, a cost segregation study can result in compelling savings. In fact, the tax benefits of this approach are well documented and many have already taken advantage of it. However, while there are benefits, it’s important to be aware of and plan for the recapture tax when conducting a study. The recapture tax requires the building owner (usually the taxpayer) to repay accelerated deductions (including from a cost segregation study) when the property is sold. Because the tax is assessed only when the property is sold, it’s important for property owners to carefully plan when they intend to sell and conduct tax planning appropriately. To help clients, prospects and others understand the tax, Hanson & Co. has provided a brief summary below.

What is the Depreciation Recapture Tax?

The recapture tax is an income tax on a gain realized when a taxpayer disposes of an asset (sells a building, for example) that previously received an offset of income through depreciation. The tax was created to close a tax loophole that many were leveraging to keep capital gains taxes low. Taking the accelerated deprecation usually allows a building owner to take deductions against ordinary income in the current year, which is a great feature of cost segregation. However, it also creates a situation that results in a lower capital gains tax when the building is sold, thus providing an additional benefit to the property owner. As a result, the tax was enacted to ensure that gains resulting from depreciation were correctly taxed.

Tax Planning Strategies

For those who are considering or have already conducted a cost segregation study and have plans to sell the property at some point, the following tax planning strategies can be utilized to offset the increased tax liability:

  • Partial Asset Dispositions –the new regulations permit a taxpayer to recognize a partial disposition when components are removed from a building and replaced or it is simply demolished. Using this approach, it’s possible to recognize losses on the remaining basis for the removed or destroyed items. Examples may include HVAC systems, new roofing or even interior and exterior windows. Through partial disposition, the property owner is shielded from related recapture on the disposed assets. In this way, the partial asset disposition strategy offers two streams of value for the taxpayer.
  • Repair vs. Capitalization Review – There has been much written about the new repair versus capitalization rules when making repairs and enhancements to properties. It’s important to work with a CPA to ensure all costs have been properly classified – especially repairs, which are immediately deducted. Not only will this help the immediate tax situation, but it will ensure there is no artificial inflation of the recapture tax.
  • Net Operating Loss – If the taxpayer has a net operating loss (NOL) from a prior year, then it’s wise to use the losses against the gain to offset additional tax liability. General business credits can also be applied to reduce tax liability, although generally the reduction impact is less than with other strategies.

Contact Us

Concern about the recapture tax should not prevent a property owner from taking advantage of cost segregation studies. However, there should be a comprehensive tax plan in place to address the recapture tax once the building is sold. If you are considering selling your building or if you would like tax planning assistance, Hanson & Co. is ready to help. For additional information, please call us at (303) 388-1010, or click here to contact us.

TaxMarc Bradac