Unlocking Tax Savings: The Benefits of a Cost Segregation Study

Woman in office taking notes.

A cost segregation study allows a business property owner to accelerate depreciation deductions. That, in turn, enables the owner to reduce current taxable income and increase cash flow.

A cost segregation study combines accounting and engineering techniques to identify building costs that are properly allocable to tangible personal property rather than real property. It then allows the personal property to be reclassified for tax purposes and deducted over a much shorter depreciation period. This strategy has been consistently upheld in the courts.

Fundamentals of Depreciation

Business buildings generally have a 39-year depreciation period. Typically, companies depreciate a building’s structural components (such as walls, windows, HVAC systems, plumbing and wiring) along with the building. Personal property (such as equipment, machinery, furniture and fixtures) is eligible for accelerated depreciation, usually over five or seven years.

Often, businesses allocate all, or most, of their buildings’ acquisition or construction costs to real property, overlooking opportunities to allocate costs to shorter-lived personal property or land improvements. Items that appear to be “part of a building” may, in fact, be personal property. Examples include removable wall and floor coverings, removable partitions, awnings, canopies, window treatments and signs.

Shine a Light on Outdoor Savings

Rules for outdoor lighting, parking lots, landscaping and fencing are tricky but can still lead to current tax deductions in certain situations. These expenditures are generally treated as capital improvements, subject to the 15-year depreciation rule. For instance, if you replace your business lighting to upgrade it or provide greater security at night, it qualifies as a deductible capital improvement. Similarly, landscaping projects designed to boost your curb appeal or provide environmental benefits are considered capital improvements.

On the other hand, routine maintenance (such as the costs of mowing and watering the lawn surrounding your business building) typically fall into the category of deductible business expenses, just like minor repairs.

Worth Checking Out

Although the relative costs and benefits of a cost segregation study will depend on your particular facts and circumstances, it can be a valuable investment.

And, under the Tax Cuts and Jobs Act, the potential benefits of a cost segregation study may be even greater than they were years ago because of enhancements to certain depreciation-related tax breaks.

Contact the office for further details.

408-252-1800

Photo by Gustavo Fring: https://www.pexels.com/photo/woman-in-office-taking-notes-4872023/

2025 Depreciation and Pension Credits: Year-End Tax Planning

Hands of someone writing in a notebook and working at a computer.

by Natalie Nguyen

As the holiday season kicks into full swing, it’s easy to get caught up in the festivities and put taxes on the back burner. But this is the perfect time to start thinking about how upcoming changes might affect your tax strategy in the new year. It’s essential to stay informed about the latest changes in tax laws, especially if you are a business owner. In this post, we’ll show you a couple of changes that are important to review as we approach 2025 relating to depreciation and pension plan credits. 

Depreciation Changes

The 2017 Tax Cuts and Jobs Act (TCJA) introduced significant changes to depreciation rules, including enhanced bonus depreciation. While these provisions have provided substantial tax benefits for businesses since its inception, the bonus depreciation has been phasing out gradually for a few years and is currently scheduled to completely phase-out by December 31, 2026.

Key Changes for 2025:

  • Bonus Depreciation Phase-Out: The bonus depreciation percentage, which allows businesses to deduct a significant portion of the cost of qualifying assets upfront, will decrease to 40% for eligible assets placed in service after December 31, 2024. 
  • Section 179 Deduction: Another method to recover all or part of the costs of certain property, up to a limit, is the Section 179 Deduction. The maximum Section 179 expense deduction is $1,250,000, and this expense is reduced by the amount of section 179 property is placed in service during the tax year that exceeds $3,130,000. For 2025, the maximum Section 179 expense deduction for sport utility vehicles over 6,000 pounds is $31,300.

Pension Plan Credits

While there are no significant changes to pension plan credits for 2025 compared to 2024, it’s crucial for businesses to stay informed about ongoing regulations and potential legislative updates.

Eligible employers may be able to claim a tax credit of up to $5,000, for three years, on ordinary and necessary costs of starting a SEP, SIMPLE IRA or qualified plan (ex. 401(k) plan). 

You qualify for this credit if:

  • You had 100 or fewer employees who received at least $5,000 in compensation from you for the preceding year;
  • You must have at least one plan participant who was a non-highly compensated employee (NHCE); and
  • In the three tax years before the first year you’re eligible for the credit, your employees weren’t substantially the same employees who received contributions or accrued benefits in another plan sponsored by you, a member of a controlled group that includes you, or a predecessor of either.

Amount of Credit

  • Employers with 50 or fewer employees: If you have 50 or fewer employees who received at least $5,000, the credit it 100% of eligible startup costs, up to the greater of:
    • $500; or
    • The lesser of:
      • $250 multiplied by the number of NHCEs who are eligible to participate in the plan,
      • or $5,000.
  • Employers with 51-100 employees: if you have 51-100 employees who received at least $5,000, the credit is 50% of your eligible startup costs, up to the greater of:
    • $500; or
    • The lesser of:
      • $250 multiplied by the number of NHCEs who are eligible to participate in the plan,
      • or $5,000

Eligible Startup Costs

You may claim the credit for ordinary and necessary costs to:

  • Set up and administer the plan
  • Educate your employees about the plan

Tax Credit for Plan Contributions

Small employers (less than 100 employees) may claim a tax credit for plan contributions made to a defined contribution plan, SEP or Simple IRA plan. The tax credit is not available for contributions to employees earning more than $100,000. (Maybe adjusted for inflation in the following years).

  • For employers with 1-50 employees, the tax credit available for each participant is:
    • First plan year: 100% of contribution, up to $1,000
    • Second plan year: 100% of contribution, up to $1,000
    • Third plan year: 75% of contribution, up to $1,000
    • Fourth plan year: 50% of contribution, up to $1,000
    • Fifth plan year: 25% of contribution, up to $1,000
  • For employers with 51-100 employees, the tax credit available for each participant is:
    • First plan year: 100% minus 2% for each employee exceeding 50 limit
    • Second plan year: 100% minus 2% for each employee exceeding 50 limit
    • Third plan year: 75% minus 2% for each employee exceeding 50 limit
    • Fourth plan year: 50% minus 2% for each employee exceeding 50 limit
    • Fifth plan year: 25% minus 2% for each employee exceeding 50 limit

Note that you cannot both deduct the startup costs and claim the tax credit for the same expenses. You are also not required to claim the allowable credit.

Auto-enrollment Tax Credit

An eligible employer that adds an auto-enrollment feature to their plan can claim a tax credit of $500 per year for a 3-year taxable period beginning with the first taxable year the employer includes the auto-enrollment feature. This tax credit is available for new or existing plans that adopt an eligible auto-enrollment plan.

Do You Need Assistance?

Navigating tax law changes can feel overwhelming, especially with everything else on your plate during the holidays. But you don’t have to feel alone. If you have questions about how the new tax laws will impact you and your business, we’re here to provide the guidance you need. Our team is ready to help you understand these changes and create a tax strategy that works best for your unique situation. Reach out to us today, and let’s ensure that you’re fully prepared for a successful 2025 tax year.

408-252-1800

Photo Credit to https://homethods.com/, CC BY 2.0, via Flickr.com.

Tax Implications of Depreciation: A Comprehensive Guide

by Natalie Nguyen

Depreciation is a key concept in accounting and finance, reflecting how an asset loses value over time due to factors like wear and tear, aging, or obsolescence. But did you know that depreciation also has significant tax implications? In this blog post, we’ll explore these tax aspects and their impact on businesses.

What is Depreciation?

Depreciation is the process of allocating the cost of a tangible asset over its useful life. It shows how companies account for the gradual loss of value in their assets.

Tax Deductions and Depreciation

For businesses, depreciation is considered an expense. Even though it’s a non-cash expense, it helps reduce taxable income. The IRS allows businesses to deduct this calculated depreciation from their corporate income taxes, which can significantly lower their tax liability and boost after-tax profits.

Bonus Depreciation

Bonus depreciation is a tax incentive that lets businesses accelerate deductions on “qualified property” in addition to regular depreciation when these assets are first put into use. This incentive encourages businesses to invest in new equipment.

Initially introduced through the Job Creation and Worker Assistance Act in 2002, this provision allowed businesses to deduct an extra 30% of the cost of eligible assets beyond the standard depreciation expense. In 2017, the Tax Cuts and Jobs Act increased the bonus depreciation rate to 100%. This rate started phasing out at the end of 2022, decreasing by 20% each year (80% in 2023, 60% in 2024, 40% in 2025, and 20% in 2026), with the provision set to expire by the end of 2026.

Eligible property for bonus depreciation includes depreciable assets with a useful life of 20 years or less, such as vehicles, furniture, manufacturing equipment, and heavy machinery. “Qualified improvement property” is also eligible for bonus depreciation.

Unfortunately, California does not conform to the federal bonus depreciation provision. While businesses can realize significant initial year tax savings at the federal level, they may find more tax savings at the state level in later years due to this lack of conformity.

Section 179 Deduction

As bonus depreciation phases out, small businesses can still leverage initial-year expensing through Section 179 of the Internal Revenue Code. Under Section 179, businesses can deduct the full purchase price of qualifying equipment bought or financed within the tax year, subject to certain limits and phase-outs. For the 2024 tax year, the federal deduction limit under Section 179 is set at $1,220,000, with a phase-out threshold starting at $3,050,000. For example, if a company purchases $1,000,000 in qualifying equipment before the end of 2024, it can deduct the entire amount from its gross income. However, if the purchase price reaches $1,500,000, it becomes subject to phase-out. Purchases exceeding $3,050,000 do not qualify for additional deductions and are handled using the standard depreciation method.

In California, the state conforms to Section 179 but caps the maximum deduction at $25,000 per year, phasing out completely when the total purchase price for the year exceeds $200,000.

Impact on Net Income

Since depreciation reduces taxable income, it also reduces the taxes a company owes, leading to a higher net income. However, it’s important to note that because depreciation is a non-cash expense, it doesn’t impact the company’s cash flow.

Understanding the tax implications of depreciation is crucial for businesses, as it can lead to significant tax savings and influence decisions regarding asset acquisition and disposal.

Photo Attribution:

MobiusDaXter, CC BY-SA 3.0, https://creativecommons.org/licenses/by-sa/3.0, via Wikimedia Commons

Sec. 179 Expensing and Bonus Depreciation: Beware of Pitfalls

Office full of chairs and desks, with two people.

If eligible, you can elect to use Section 179 expensing or bonus depreciation to deduct a large portion of the cost (and in some cases the full cost) of eligible property in the year it’s placed in service. Alternatively, you may follow regular depreciation rules and spread deductions over several years or decades, depending on how the asset is classified under the tax code.

While taking current deductions can significantly lower your company’s taxable income, it isn’t always the smartest move.

Sec. 179 and Bonus Depreciation 101

Section 179 expensing may allow you to currently deduct the full cost of purchasing eligible new or used assets, such as equipment, furniture, off-the-shelf computer software, and qualified improvement property (QIP). An annual expensing limit applies ($1.16 million for 2023 and $1.22 million for 2024), which begins to phase out dollar for dollar when asset acquisitions for the year exceed the applicable threshold ($2.89 million for 2023 and $3.05 million for 2024). You can claim the election only to offset net income, not to reduce it below zero to create a net operating loss.

First-year bonus depreciation is available for qualified assets, which include new tangible property with a recovery period of 20 years or less (such as office furniture and equipment), off-the-shelf computer software and water utility property. Under the TCJA, through 2026, the definition has been expanded to include used property and qualified film, television and live theatrical productions. In addition, QIP is now eligible for bonus depreciation. For 2023, bonus depreciation was 80%. It drops to 60% for 2024, to 40% for 2025 and to 20% for 2026. After that, it will be eliminated, unless Congress acts to extend it.

When to Consider Forgoing These Breaks

Here are two examples when it may be preferable to forgo Sec. 179 expensing and bonus depreciation.

You’re planning to sell QIP. If you claim Sec. 179 expense or bonus depreciation on QIP and sell the building soon, this current write-off may be a tax trap. That’s because your gain on the sale up to the amount of Sec. 179 or bonus depreciation deductions you’ve claimed will be treated as “recaptured” depreciation that’s taxable at ordinary-income tax rates, up to 37%. But if you deduct the cost of QIP under regular depreciation rules (generally, over 15 years) and sell the building, any long-term gain attributable to the deductions will be taxable at a top rate of 25%.

You’re eligible for the qualified business income (QBI) deduction. This deduction allows eligible business owners to deduct up to 20% of their QBI from certain pass-through entities, such as partnerships, limited liability companies and sole proprietorships. The deduction can’t exceed 20% of an owner’s taxable income, excluding net capital gains. (Other restrictions apply.)

Claiming Sec. 179 or bonus depreciation deductions reduces your taxable income, which may deprive you of an opportunity to maximize the QBI deduction. Because the QBI deduction is scheduled to expire after 2025, taking full advantage of it while you can will generally make sense.

Timing Is Everything

Keep in mind that only the timing of deductions is affected by the strategy you choose. You’ll still have an opportunity to write off the full cost of eligible assets if you forgo Sec. 179 expensing and bonus depreciation; it will just be over a longer time period. Contact the office for help analyzing your company’s overall tax benefit picture and determining the optimal strategy.

408-252-1800

Photo by StartupStockPhotos from Freerange Stock.