By: Robert Taylor, MBA
If you have owned a commercial building for several years, a cost segregation study can still be applied. It is a simple process that can lead to large depreciation deductions in the current tax year.
When you apply a cost segregation study to a building you have owned for more than a year, you can “catch-up” on depreciation. This application leads to large depreciation deductions in the year the cost segregation study is applied. Any commercial building that has been in-service or remodeled since December 31, 1986, can have cost segregation applied.
The catch-up depreciation is the difference between previously taken depreciation and the depreciation if on day-one cost segregation was applied. To get this catch-up depreciation, you must change your depreciation method to match the results of the cost segregation study. To change your depreciation method, you must file a Form 3115 Change in Accounting Method Form. There is no need to amend any prior tax returns. Through the Form 3115, the depreciation change and resulting depreciation deduction can be done in the current tax year.
The Form 3115 contains a 481(a) adjustment, which represents the additional depreciation you are entitled to because your depreciation method changed. To calculate the 481(a) adjustment, look at the depreciation you have taken to date using your current depreciation method. Then, calculate the depreciation taken if the cost segregation had been applied at the building in-service date. The difference between the two figures is the additional depreciation amount you are entitled to take in the current tax year. Typically, this adjustment is taken as an “other deduction” on the tax return.
Form 3115s are completed for a variety of reasons. The specific change to implement a cost segregation study is Designated Change Number 7. This type of change in an “automatic consent” change which means there is no lengthy and costly pre-approval process to implement this change. The Form simply needs to be completed and correctly applied to the tax return.