Depreciation Strategies for 2021 Tax Planning: Step-up-in basis

Cost Segregation studies are widely known to be a valuable tax planning tool for when property owners are acquiring, constructing or renovating a property. However, there are also other times that cost segregation studies can provide value that may be overlooked, such as when a step-up-in basis occurs.

If a 754 Election is in place for partnerships or LLCs, there are two common events that can trigger what’s called a “step-up-in basis”. When there is a redemption or death of a partner or there is a sale of an interest of an existing partner to a new one, the assets’ tax basis in the partner’s share is adjusted to the fair market value (FMV) for each asset. The value that is adjusted to the FMV of the asset becomes the step-up asset. If the asset that experienced a step-up is a depreciable asset, then the step-up in basis will also be depreciable. The depreciable property is typically placed into a 27.5 or 39-year life, even though it may include assets that could be depreciated much quicker, such as equipment. If the property remains in the 27.5 or 39-year life, there could be significant tax savings being overlooked if a cost segregation study is not being utilized. A cost segregation study can reclassify the property included in the step-up into 5, 7, and 15-year property. By doing so, a study will create large depreciation deductions early in the asset’s life to increase cash flow and reduce taxable income.

In addition to partnership transactions, a cost segregation study can create significant tax savings as a part of estate planning. When assets are passed to beneficiaries in an estate, the assets will experience a step-up-in basis to the FMV of the asset at the date of the death. This provision is in place to allow decedents to pass assets to their heirs without having to be subject to capital gain taxes when transferring the property to the recipients. Just like the partnership step-up procedures mentioned, any depreciable step-up is typically placed into 27.5 or 39-year class life. A partnership or decedent that took advantage of cost segregation study prior to the step-up with see a larger stepped-up basis due to the reduced tax basis of the asset. Since the calculation of the step-up is calculated on the delta between the FMV and the tax basis, the cost segregation study previously conducted increases the value of the stepped-up asset, if done correctly. In addition, any property that is transferred as a part of an estate is not subject to recapture, so completing a cost segregation study prior to the step-up could create permanent tax savings by taking advantage of depreciation deductions that might have never been used. Completing a study prior to the step-up-in basis can maximize tax savings and increase cash flow if performed at the right time.

Depreciation strategies such as completing cost segregation studies when tax planning for a step-up-in basis can significantly reduce taxable income and increase cash flow. It is essential to discuss depreciation strategies early in the tax planning process with fixed asset experts such as McGuire Sponsel to make sure property owners are taking full advantage of any available opportunities to optimize depreciation deductions, reduce taxable income and increase cash flow.

Interested in learning more about this and other depreciation strategies that can drive value for your clients’ business? Watch our webinar, Depreciation Strategies for 2021. In this session, Dave McGuire discusses high end depreciation strategies to consider for 2021 and beyond, including when to opt out of bonus depreciation, using general asset accounts for tax planning, and more.

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