Maximizing Real Estate Incentives for Manufacturing and Distribution

Understanding real estate tax incentives is vital for organizations in the manufacturing and distribution industry. Knowing which tax incentives suit an organization’s unique needs can increase visibility and profit while aligning with business goals. For instance, cost segregation and 179D deductions interplay to maximize tax savings from a retail manufacturer’s distribution perspective. Organizations can experience accelerated depreciation, enhanced cash flow, energy efficiency incentives, and implement a comprehensive tax strategy when activated together.  

Cost Segregation Studies  

For commercial properties, the real property tax life is typically 39 years. This means that if a taxpayer were to invest in a manufacturing facility, whether through a renovation or newly purchased or constructed facility, they would depreciate the facility over 39 years. 

Cost segregation is an IRS-approved engineering-based study. The purpose of the cost segregation study would be for the engineer to identify and reclassify assets by placing them into three buckets: real property (39-year), tangible personal property (5-year), and land improvements (15-year). Assets are then quantified based on IRS pricing methodology to determine how much of the overall basis can be reclassified into each bucket. By segregating assets into these buckets, the taxpayer can depreciate eligible assets faster, allowing investors to experience tax savings now and cash flow in earlier years of owning the property. 

To complete a cost segregation study, an engineer conducts a site tour of the property and analyzes the various components of the property. This analysis includes properly identifying and breaking down the different assets to their appropriate useful lives for depreciation purposes. Without a cost segregation study, all assets would have to be depreciated over their general real property category, which, as mentioned above, would be 39 years.  

In addition to the shorter useful life, there are other significant tax benefits to having property that is reclassed from real property. 

Bonus Depreciation and Benefits

One such example of a significant tax benefit for assets with shorter depreciable lives is the potential eligibility for bonus depreciation.  

Bonus depreciation is a tax incentive that has experienced significant changes due to the Tax Cut and Jobs Act (TCJA). Prior to the TCJA, bonus depreciation was not eligible for purchased assets; it was only for brand-new assets. This means that if a company bought a property that had already been placed in service by another taxpayer, it would not have been eligible for bonus depreciation in the past. With this change in the rules, taxpayers can take advantage of this federal tax benefit by allowing them to take bonus depreciation on eligible assets.  

Through a cost segregation study, by reclassifying eligible assets to a five or 15-year bucket, assets can depreciate even faster, as almost all assets classified as under 20 years are eligible for bonus depreciation, with some limited exceptions. This allows taxpayers to take significant additional deductions in the first year. 

Bonus Depreciation Legislation

As a result of the TCJA, assets purchased and placed in service from September 27, 2017, through 2022 were eligible for an immediate 100% deduction. However, since 2022, there has been a consistent phase-out of 20% annually. This phase-out has reduced the rates to 80% in 2023, and 60% in 2024. As the future of bonus depreciation remains ever-changing and unknown, it is important to note that it still has significant advantages and benefits, especially when combined with other tax incentives. 

What Is Section 179D Deductions?  

Since 2006, manufacturing and distribution companies have benefited from 179D deductions as it applies to all commercial buildings, including new constructions and renovations. These deductions were introduced as part of the Energy Policy Act to reward taxpayers who implemented strategies to increase overall energy efficiencies in building components, specifically HVAC systems, interior lighting, and building envelope when constructing and renovating commercial properties.  

The deduction has been historically quantified and determined by comparing the increase in the energy efficiency of the overall project to the baseline as determined by the 2007 ASHRAE standard. 

Benefits of the Inflation Reduction Act (IRA) on 179D 

The Inflation Reduction Act (IRA) enhanced 179D deductions in several ways, making them more accessible and beneficial to M&D companies. Before the act, the deduction was $1.80 per square foot. The IRA increased this benefit to a potential $5 per square foot, adjusted annually for inflation. 

It is important to note, however, that the IRA does include a major caveat to be eligible for this new maximum $5 per square foot, prevailing wages. The IRA included two different measures for the deduction: one for taxpayers who do not pay prevailing wages and one for taxpayers who do pay prevailing wages throughout the project cycle. See chart below. 

Another positive outcome of the IRA is that deductions can happen more than once. Before it was a one-time deduction, so if an organization wanted to update a facility in phases, it would only be eligible for the Section 179D Deduction at one given time, i.e., at the end of the overall project. 

IRS Form 3115 

The benefits of these two tax-saving strategies are not lost if one has not completed a cost segregation study in the year the assets were placed in service. By utilizing IRS Form 3115 – Changes in Accounting Methods, taxpayers can take a one-time deduction to catch up on the benefits missed in a prior tax year for these deductions. By using Form 3115, the taxpayer does not have to amend a prior year tax return but rather reflect the change in the current tax year to which the form is attached.  

It is important to note that the rules under which the tax payer would calculate such catch-up would be the rules in place for the tax year that the assets were placed in service. This means that even if a taxpayer is taking bonus depreciation for assets placed in service in 2022 on a 2024 tax return, the taxpayer would be eligible for 100% bonus depreciation on such assets and not limited to the 2024 bonus rate of 60%. 

This can be a powerful tool in that many taxpayers may already have offset their entire tax liability in the year the new property is placed in service, and therefore may utilize this catch-up deduction in a future year when there is a taxable income to offset. 

Leveraging Real Estate Tax Incentives 

Whether you want to invest in a renovation or start fresh with a new building, exploring these tax incentives can play a crucial role in your company and the M&D industry. Companies can better strategize tax plans, increase energy efficiency, and experience enhanced savings and cash flow by continuing to invest in property, manufacturing, and distribution. For more information or to determine the best strategy for maximizing benefits, watch EisnerAmper’s online webinar or contact us below.