Understanding commercial property and depreciation is essential. For many businesses, a commercial property investment requires significant upfront capital. These resources are being taken away from other activities like hiring talented staff and marketing, so you have to be really sure that it’s how you want to spend your money.
Understanding how commercial property depreciation works is not just an accounting technicality. It’s one of the most important financial strategies to ensure that your company succeeds long term and that you maintain a healthy balance sheet.
How the 39-year schedule works
Commercial property depreciation is essentially a tax deduction that allows businesses to recover the cost of an income-producing property. It sounds complicated, and the wording isn’t always helpful, but the idea is that the IRS compensates you for the value that the building loses over its 39-year lifetime. The period is set strictly at 39 years, and there is a straight-line depreciation method. This means that your business can deduct a steady, equal portion of the building’s cost basis each year from taxable income.
You can’t depreciate the value of the land that the building sits on, because land inherently doesn’t depreciate over time. Instead, you can only depreciate the value of the structures and additional capital improvements that you make.
Unlocking cash flow with cost segregation
Another thing you can do is unlock cash flow with cost segregation. The idea here is to segregate different elements of the property to take advantage of various depreciation rules. The standard 39-year schedule provides general building tax relief, but there are other types of relief available. For example, some elements of the building can be reclassified into shorter duration recovery periods, usually 5, 7, or 15 years. When depreciation is accelerated significantly, it can massively reduce the tax bills that a company faces in its first few years.
It can, of course, be complicated, which is why many people use a depreciation calculator. These are essentially tools that will do the lion’s share of the calculation for you. All you need to do is give them basic information about the value of your property and the types of improvements that you’ve made, and the calculator will do the rest.
Navigating bonus depreciation and recapture
You should also work hard to understand the tax code changes that relate to bonus depreciation and recapture. Bonus depreciation means that businesses can front-load some more of the depreciation benefit on short assets in the very first year. This can significantly reduce taxes payable during that year, often more than 100%.
Of course, the rules vary by legislation and area, but it can be a great way to maximise the return on first-year investment. You’ll need to think carefully about your exit strategy when you decide to sell the property. The IRS will want some of the tax benefits you receive through a mechanism called depreciation recapture.
Ultimately, you will pay taxes on the amount that you previously deducted if you wind up selling the property for a profit.