As we tuck into our holiday plans, the last thing most of us want to think about is how we’re going to file this year’s tax returns, unless Mariah Carey composes a catchy Christmas jingle dedicated to CPAs. But the clock is ticking loudly for property owners and investors to make crucial decisions that could pack a big punch towards their 2022 tax burden. Even with the new year fast-approaching, you still have time to take advantage, or at least, be informed, of any last-minute deductions in order to maximize your benefits.
Know about deductions ending this year
Under the Tax Cuts and Jobs Act (TCJA) of 2017, businesses have until December 31, 2022 to take advantage of the full extent of the bonus depreciation deduction. Bonus depreciation is a tax-saving approach that enables firms, owners, and investors to write off a specific portion of an asset’s cost in the first year it is put to use. The deduction enables owners to deduct a larger portion of an asset’s cost in the year that it begins to be used. However, starting next year, the bonus depreciation will gradually wind down.
2022 is the final year where 100 percent bonus depreciation will be in effect. By 2023, that deduction will be reduced to 80 percent. The bonus depreciation deduction will be knocked down by 20 percent for each year until it completely vanishes in 2027. Real estate players who intend to buy a piece of property that would be eligible for bonus depreciation may want to do so as soon as possible in the absence of a legislative change.
Congress initially wrote and later expanded the breadth of the bonus depreciation deduction as a stimulus measure that would encourage business owners to purchase more assets, so the gradual phase-out of the bonus depreciation deduction will have a ripple-effect beyond the world of real estate. Almost any kind of new or used tangible personal business property that is purchased from a non-relative and has a useful life of 20 years or less can qualify for the deduction. Examples include equipment, furniture, fixtures, machinery, computer software, and costs of qualified film or television productions, and live theatrical productions (computers, which had been previously included in the older version of the law, were removed from this category under TCJA). But in order to make the bonus depreciation deduction applicable to a real estate asset, a cost segregation study needs to be performed.
Schedule a cost segregation study
Though the components of a building can depreciate over five, seven, or 15 years if purchased separately, they are often acquired as part of the construction of a building and written off over the same useful life as the rest of the structure (fun fact, the IRS deems a “useful life” of a non-residential building to be 39 years, whereas a residential building only has a useful life of 27.5 years). A cost segregation study‘s main objective is to identify all costs associated with the property that can be written off over five, seven, and 15 years.
Cost segregation is a method of tax deferral that frontloads real estate asset depreciation deductions into the first few years of ownership. For federal and state income tax reasons, a cost segregation study separates the cost components of a building into the appropriate asset classifications and recovery periods in order for them to be applicable for the bonus depreciation deduction. However, cost segregation studies are an extremely methodical process involving a team of tax advisors and engineers working together analyzing each component of a building to determine whether or not they apply for the deduction. After handing all the relevant information over to the appraisers, you can expect a timeline of four to eight weeks for the study to be completed. Which is…more time than what’s left in this year.
But owners and investors looking to take advantage of the bonus depreciation deduction for a new property purchase last-minute need not despair! Cost-segregation studies don’t necessarily need to be carried out within the same fiscal year that the property gets acquired. Cost segregation studies only need to be done before the tax return is filed. Property owners can opt to file for an extension, meaning that they will have until October 15, 2023 to arrange a cost segregation study.
Even beyond 2022, owners and investors can still greatly benefit from a cost segregation analysis if they want to buy a property that qualifies for bonus depreciation. After all, the bonus depreciation is only reducing its benefit, not vacating itself from the tax code altogether by next year. It could be a good idea to do so right away and put it into use as soon as possible to maximize your options.
Read up on your building’s energy efficiency
The Inflation Reduction Act of 2022 made a massive impact on the real estate industry, and the extension of the 179D Energy Efficient Buildings Tax Deduction is one of the provisions of the law used to encourage investment in sustainable infrastructure.
For businesses in the fields of architecture, engineering, and construction, the 179D Commercial Building Energy-Efficient Tax Deduction (Section 179D) may offer ongoing tax advantages. 179D offers building owners that create new property, rehabilitate existing energy efficient buildings, or develop government-owned structures a deduction of up to $1.88 per square foot. There is a 250,000 square foot maximum benefit that may be deducted, so for an eligible building, the deduction would increase from a $470,000 tax cut at the current rate to a $1.25 million tax break with the new rate. Following the completion of construction on designed projects for government-owned buildings, these entities may claim the deduction.
Building owners can retrospectively claim the deduction going all the way back to the 2006 tax year by submitting an accounting method adjustment, but a business should make the claim in the tax year that the building is put into use. Contrary to building owners, an architecture, engineering, or construction business must file an amended tax return in order to claim the deduction if it is missed on a current-year tax return. This can result in a major administrative burden, particularly if a business wants to apply the deduction retrospectively for several years.
Be aware of changes to charitable donation deductions
‘Tis the season of giving after all. If the holiday spirit is putting you in a generous mood, making a donation to a good cause can not only be an uplifting experience, it can also reduce your tax burden. However, the two special tax regulations that permitted taxpayers to claim deductions of amounts up to 100 percent of their adjusted gross income (AGI) and a specific amount of cash contributions, even if they did not itemize their 2021 income taxes, have expired and were not extended by Congress.
The standard restriction that taxpayers can only deduct charitable contributions if they itemize their tax deductions on Schedule A is now back in effect. Taxpayers can only deduct up to 60 percent of their financial donations to operational foundations and public charities as charitable contributions. Still, making a charitable contribution is inherently a selfless act that’s a worthwhile endeavor regardless of any tax benefit, the deduction is just icing on the cake.
Whether or not you’ll be springing for any of these deductions, now’s the time to get your documents together. As any CPA will tell you, being organized is the best gift you can possibly give them…besides, you know, an actual present.