Commercial Properties: The Study Decision

Commercial properties come in enormous variety, and so do the study decisions. A small office condominium and a large industrial park present quite different pictures. This page sets out the factors that tend to matter.

Depreciation baseline

The building is generally depreciated over 39 years. That slow pace is what makes acceleration attractive for some owners. See Nonresidential Property and the 39 Year Class.

Components worth a look

• Tenant improvements and interior build-outs.
• Site work: paving, lighting, drainage, landscaping.
• Specialized electrical and plumbing.
• Security, communication, and other systems.
• Signage.
• Loading docks and equipment in industrial settings.

See Land Improvements and the 15 Year Class and Examples of 5 and 7 Year Property in Rentals and Commercial Buildings.

Owner-occupied versus leased

Owner-operators who use the building in their own business may be able to use deductions against business income, subject to their limits. The building may be held by a separate entity that leases to the business. Passive rules and the grouping of activities can matter. Ask your preparer.

Landlords with unrelated tenants generally have rental activities. Passive rules typically apply unless an exception is met. See The Passive Activity Loss Rules and Cost Segregation.

Tenants and improvements

If a tenant paid for improvements, the tenant may depreciate them, and the landlord's treatment depends on lease terms and the nature of the improvements. If the landlord paid, the landlord's study should capture them. Clarify.

Leases and triple net structures

Triple net leases shift many expenses to the tenant, but the landlord still depreciates the building. The study is about the landlord's basis. Ask whether the lease affects who owns certain components.

Investment property scale

Commercial buildings tend to have larger bases. As with multifamily, the fee is a smaller share of basis for larger properties. See Cost Segregation Study Fees: General Ranges.

Hold period

Commercial owners often hold for long periods, sometimes exchanging into other property. This can favor the timing benefit. But some have short business plans. See Hold Period and the Decision and Section 1031 Exchanges and Depreciation Recapture.

Vacancy and lease-up

If the building is being leased up, tenant improvements will be built as tenants arrive. Each may have its own placed-in-service date. Coordinate. See Timing for New Construction and Renovations.

Environmental and specialized issues

Specialized facilities can have complex components. Confirm your provider has relevant experience. See How to Vet a Cost Segregation Provider.

Risks

Large deductions attract attention when they are unusual relative to income. Documentation matters. See Audit Defense and Documentation for Cost Segregation.

Questions for advisors

• What is our recovery period for each part of the building?
• Can we use the deductions this year?
• How will the study interact with our lender covenants?
• How would a sale be affected?

Hypothetical

See Hypothetical: A Small Commercial Building for a labeled hypothetical.

Illustrative scenarios in words

An owner-user buys a small building to house their own business. The building is held by a separate entity that leases it to the business. The rental income is from a related party, and special grouping rules may apply. A study may create deductions that the owner can use against business income through the entity structure, subject to the rules. Ask your preparer.

An investor buys a multi-tenant office building. Tenant improvements vary by suite and lease. A study allocates costs among suites and building systems. The investor also plans to sell after several years. Recapture and sale timing are relevant.

A developer builds a small industrial building. Actual costs are available and the site work is significant. A study using actual costs can be straightforward, and the developer may plan to hold for a long term.

Documentation that matters most

Leases, tenant improvement agreements, invoices, drawings, permits, certificates of occupancy, and rent rolls. For owner-users, also keep documentation of the business use of the building.

Financing and reserves

If a lender requires reserves for replacements, those funds and their use may interact with your depreciation records. Keep track of what was replaced with reserve funds and what was capitalized.

Practical next steps

Gather the documents above, ask two or three providers for scopes and quotes, and ask your preparer to model the usability of the deductions. Then compare to your hold plan and decide.

What lenders and buyers may care about

Lenders generally focus on cash flow and collateral, not on tax depreciation. Buyers may ask for depreciation records to evaluate their own tax position. A well-organized study and schedule can help in a sale. Provide them when appropriate and consistent with your confidentiality obligations.

Choosing scope for multi-building sites

If a site has several buildings, decide whether to study all or only the largest. Buildings with similar construction may allow efficient analysis. Ask the provider how they would approach the site and whether the report will treat each building separately, since each needs its own schedule.

Signals to move ahead

Usable deductions, a sizable basis, meaningful site work or specialized components, and a hold period that supports the timing benefit are signals to move ahead. If any is weak, consider waiting or focusing on a smaller scope.

Mixed-use nuance

If part of the building is residential and part is commercial, classification and recovery periods may differ by portion, and passive analysis may differ as well. Ask your preparer how the building should be divided and whether separate schedules are needed.

Next steps

Review Nonresidential Property and the 39 Year Class if you have not, then use the Cost Segregation Decision Checklist.