Accounting · Automation · Strategy
This guide gives owners a high-level roadmap—and gives practitioners quick code anchors—on how depreciation works, how the Tangible Property Regulations drive capitalization vs. deduction, and how to think about cost segregation and timing.
1) Depreciation Basics (What & Why)
- Authority: IRC §167 (depreciation), §168 (MACRS), §168(k) (bonus), and §179 (expensing).
- Concept: Capital assets used in business are recovered over time (class lives under MACRS). Real property is generally 27.5 or 39 years; equipment often 5–7 years; land is not depreciable.
- Accelerators: Bonus depreciation under §168(k) (phase-down schedule applies) and §179 expensing (subject to business income limits and investment caps).
2) Tangible Property Regulations (TPR): Capitalize vs. Expense
Authority: Regs under §1.263(a)-1, -2, -3 (plus safe harbors). The core question: is it a repair/maintenance (deduct) or an improvement (capitalize)?
- Improvements (capitalize) occur when there’s betterment, restoration, or adaptation to a new use (BRA tests) under Reg. §1.263(a)-3.
- Repairs (expense) keep property in ordinarily efficient operating condition without materially increasing value or life.
- De Minimis Safe Harbor: Reg. §1.263(a)-1(f) (e.g., ≤ $2,500 per invoice/item for taxpayers without AFS; higher with AFS).
- Routine Maintenance Safe Harbor: Reg. §1.263(a)-3(i) allows expensing recurring activities expected more than once during the asset’s class life.
- Accounting · Automation · Strategy Reg. §1.263(a)-3(h) for certain building expenses under gross receipts/building basis thresholds.
Practice tip: Set capitalization thresholds in a written policy; apply safe harbors consistently; document major projects against BRA tests.
3) Cost Segregation—What It Is and Why It Matters
Cost segregation reclassifies building components into shorter-life MACRS classes (e.g., 5, 7, 15-year property and land improvements) so you accelerate deductions, often combining with bonus or §179 where eligible.
- Authority: MACRS §168; case law and IRS guidance allow engineering-based studies to identify personal property and land improvements.
- Benefits: Larger deductions sooner; improved cash flow; potential shelter for operating income (subject to PAL rules for rentals under §469).
- Drawbacks/Trade-offs: More recapture risk as §1245 on disposition; compliance costs; possible state non-conformity (bonus addbacks).
4) State Considerations & Bonus Addbacks
- Many states do not fully conform to federal bonus under §168(k). Expect partial or full addbacks and separate state depreciation schedules.
- NOL usage may be limited or disallowed across states; separate-company filing states may not allow another state’s NOL; matching issues arise when federal used only up to 80% of taxable income (§172(a)(2)) but state rules differ.
5) Timing Strategy: You Don’t Have to Do Cost Seg in Year 1
If you missed a cost segregation in the placed-in-service year, you can still capture the benefit later with an accounting method change (Form 3115) and a §481(a) catch-up (current-year deduction for cumulative difference).
- Why that’s powerful: You can pull deductions into a year that actually has income—often better than creating an NOL that may be limited to 80% and complicated at the state level.
- Works for existing buildings and improvements; coordinate with any prior partial asset dispositions and capitalization studies.
6) §179 vs. Bonus (High-Level)
- §179 is elective expensing limited by taxable income and investment caps; useful for targeting specific assets or controlling state outcomes where bonus is disallowed.
- Bonus §168(k) applies broadly to qualified property (subject to phase-down), not limited by taxable income; large, rapid deductions but with state differences.
7) When to Call a Professional
- Buildings with significant improvements, renovations, tenant build-outs, or planned dispositions.
- Multi-state operations, real estate partnerships, or complex ownership (S corps/partnerships) where PAL, basis, and at-risk rules interact.
- Considering late cost seg with a §481(a) adjustment (Form 3115) or navigating state bonus/NOL conformity.
Code anchors (quick reference): §167, §168, §168(k), §179, §172(a)(2); Reg. §1.263(a)-1, -2, -3 (de minimis, routine maintenance, SHST), and §481(a) (method change catch-up).