Duvall & Associates, Inc.
BUSINESS ADVISOR NEWSLETTER
 

Creativity goes a long way for cost allocation

- by Alan Duvall 

Published in Dayton Daily News April 2, 2006  

Things are not always what they appear to be. 

Take real estate acquired for business.  Federal tax law allows the original cost of a building to be depreciated ratably over 27.5 years if residential and 39 years if non-residential.  So if a non-residential business building is acquired for $780,000 - a depreciation deduction of $20,000 per year for 39 years is permitted.  That's a long time to expense your investment. 

Fortunately, tax law allows an owner to tear the building cost down into distinct components, each possessing faster write-off periods than a simple building.  Two key issues in cost segregation are:  Is the component removable and is it essential to the basic building structure. 

Fixture and equipment components can be expensed over seven years.  Fixtures would include carpeting, signs, decorative lighting and cabinets. 

Creativity helps to identify equipment.  Using a restaurant as an example, appliances are obviously equipment.  But electrical wiring associated with stoves, plumbing to kitchen sinks and ductwork for exhaust fans can be deemed equipment even though imbedded behind walls and hardly removable.   

Some office equipment components such as wiring for telephones and computers can be depreciated over 5 years. 

Cost allocated to land cannot be depreciated.  However, certain land improvements such as sidewalks, driveways, landscaping and sewers can be written off over 15 years. 

Going back to our original example, if the buyer could carve out of the $780,000 building cost $20,000 office wiring, $50,000 for equipment, $40,000 for fixtures and $90,000 for land improvements, depreciation expense for the first two years would be $37,000 and $52,000 respectively.   

Compare the lower $20,000 per year deduction if all costs were simply labeled building.  The ability to front-end load deductions saves taxes in initial years of acquisition.  

If constructing a new building, work with contractors prior to the building's completion to document segregated component costs.

Acquisition of an existing building requires a written buyer-seller agreement as to cost breakdowns since allocations tax-benefiting the buyer typically hurt the seller.   

Remember – it’s not just a building – it’s a structure full of tax opportunities. 

Alan Duvall is a certified public accountant in Dayton.  Contact him at Alan@Duvallcpa.com.