The Difference Between Reclassification and Bonus Depreciation

[Julio Gonzalez]

When talking about cost segregation studies, a common confusion is the difference between reclassification and bonus depreciation and the role that each of them plays in terms of taxes. Let’s dive in.

Reclassification

During a cost segregation study, the real property is reclassified into new categories of personal property based on its useful life. This can have a very beneficial impact as personal property typically has a much shorter useful life for depreciation purposes than real property.

For example, if you are getting a cost segregation study performed on a car wash, there will most likely be assets that have been classified as part of the building but are able to be reclassified to real property and depreciation over a shorter useful life such as 5,7 or 15 years rather than 27.5 or 39 years. This significantly accelerates the depreciation schedule leading to larger deductions in the beginning years of the assets, reducing your taxable income and increasing your cash flow.

Bonus Depreciation

Another key part of a cost segregation study is bonus depreciation. The Tax Cuts and Jobs Act (TCJA) of 2017 allows businesses to write off 80% (in 2023) of the cost of qualifying property in the year that it is placed into service. This can lead to significant tax write-offs.

However, bonus depreciation is currently being phased out. The bonus depreciation is based upon the year the property is placed into service. Bonus depreciation is 100% for 2022, 80% for 2023, 60% for 2024, 40% for 2025, 20% for 2026 and is completely phased out in 2027. Regardless of the bonus depreciation phase out, it continues to be a favorable strategy that creates significant tax savings.

[Eric Williams]

Quote from @Julio Gonzalez:

When talking about cost segregation studies, a common confusion is the difference between reclassification and bonus depreciation and the role that each of them plays in terms of taxes. Let’s dive in.

Reclassification

During a cost segregation study, the real property is reclassified into new categories of personal property based on its useful life. This can have a very beneficial impact as personal property typically has a much shorter useful life for depreciation purposes than real property.

For example, if you are getting a cost segregation study performed on a car wash, there will most likely be assets that have been classified as part of the building but are able to be reclassified to real property and depreciation over a shorter useful life such as 5,7 or 15 years rather than 27.5 or 39 years. This significantly accelerates the depreciation schedule leading to larger deductions in the beginning years of the assets, reducing your taxable income and increasing your cash flow.

Bonus Depreciation

Another key part of a cost segregation study is bonus depreciation. The Tax Cuts and Jobs Act (TCJA) of 2017 allows businesses to write off 80% (in 2023) of the cost of qualifying property in the year that it is placed into service. This can lead to significant tax write-offs.

However, bonus depreciation is currently being phased out. The bonus depreciation is based upon the year the property is placed into service. Bonus depreciation is 100% for 2022, 80% for 2023, 60% for 2024, 40% for 2025, 20% for 2026 and is completely phased out in 2027. Regardless of the bonus depreciation phase out, it continues to be a favorable strategy that creates significant tax savings.

 Look I'm not disagreeing but it needs to be added the value of a deduction is not purely based on timing. Bonus depreciation is allowed on 212 property unlike 179 first year expensing. 

But don't forget if the activity meets the active conduct test of 179 I can take bonus and then 179 the remaining amount assuming other conditions are met.

The issue is that even if you take bonus, you need to make sure there's some income that it can offset, preferably income amounts at the highest marginal rate. 

But since rental activities are per se passive, not only might you need to all basis requirements (704(d), 465, 469) if a partnership for it to get to the 1040, but you are also going to need either enough income to absorb it to avoid passive limitations, or be lucky enough to benefit from the active participation of 469 up to 25k.

Also if you dispose of it soon after you have ordinary recapture under 1245. The problem is it's occurring in the year of disposal, potentially exposing the taxpayer to higher tax brackets from the disposal, which now include the ordinary recapture.

Again, not disagreeing.