By Matthew Billman, CliftonLarsonAllen
Tax reform lowered tax rates across many sectors starting on January 1, 2018. This rate shift presents a special opportunity for many businesses to generate permanent tax savings — even if they’ve already filed their tax returns — by taking allowable deductions in the 2017 tax year. (Generally speaking, taxable income will be subject to lower tax rates in 2018 compared to 2017.)
One such deduction opportunity is the fixed asset depreciation study. It allows qualifying businesses and real estate owners to immediately generate quicker depreciation deductions that can reduce or eliminate taxable income and increase cash flow in the current year.
A manufacturer or owner of an apartment or commercial real estate building may be able to break out appliances, electric panels, data wiring, cabinets, and other personal property into shorter asset lives.
What is a fixed asset study?
Many businesses and property owners don’t realize their assets may be eligible for reclassification into shorter tax lives.
For example, a manufacturer or owner of an apartment or commercial real estate building may be able to break out appliances, electric panels, data wiring, cabinets, and other personal property into shorter asset lives. The study identifies the assets in those buildings that were not previously broken out.
How it works
A fixed asset study provides a detailed analysis of the capital assets placed in service after January 1, 1987. The study works by identifying specific asset costs and then reclassifying them into the proper asset lives through an automatic change in accounting methods. IRS Revenue Procedure 87-56 provides the asset categories that are allowable by law.
A study typically reallocates from 15 to 40 percent of a company’s depreciable asset base into shorter tax lives. It utilizes an engineering-based approach to identify areas for reallocation. For example, a $1 million asset reclassified from a 39-year life to a five-year life will generate 1,300 percent more depreciation deductions in the first two years after reclassification.
Fixed asset study qualifications
A prime candidate for a fixed asset study is a company with a general asset cost basis of $1 million or more for assets placed in service after January 1, 1987. These assets must have tax lives greater than 15 years.
The study provides the greatest benefit to a profitable business that has paid (or is expecting to pay) federal and state income taxes.
Tax advisors have been working with their clients to identify deduction opportunities and increase cash flow. The tax reform effective in 2018 and income tax rate shift opened a unique window to revisit asset cost classification.
The study itself became more viable as a tax-saving strategy starting in 1996, when the IRS issued a revenue procedure related to the change in accounting methods for depreciation and amortization. The procedure provided for an automatic change in the accounting method using IRS Form 3115.
Reclassifying allows taxpayers to catch up on depreciation deductions in the current tax year that could have been taken in prior years. Favorable case law permits the reclassification to shorter tax lives, thereby triggering larger depreciation deductions and cash flow through current year tax savings.
Additional benefits of a fixed asset study
The benefits of a study go beyond immediate tax savings and cash flow. It can help businesses:
- Generate a detailed fixed asset listing to more easily identify future asset dispositions
- Develop a process and roadmap for capitalizing future asset additions
- Deduct prior year eligible repairs in the current year
- Take the deductions with minimal time required of company personnel
Matthew Billman is a CLA Director working out of Greenwood Village, CO. He can be reached at matthew.billman@CLAconnect.com or 1-303-265-7823.
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