In recent months, concerns over the economy have led to talk of a possible recession, and some business owners are starting to make decisions in preparation for the economic changes that might result. Businesses and professionals who plan for a recession will not only be able to weather these changes but also may be in a position to capitalize on opportunities as they present themselves.
In recessionary times, businesses often increase their cash reserves. They do this not only to plan for potential slowdowns in collections but also to provide a war chest to capitalize on potential business opportunities. During a recession, assets often become cheaper (such as the decline in real estate values during the Great Recession in 2008). Having access to cash could allow a business to pay down debt in preparation for a slowing business market. It also enables a business to be adaptable, to weather the economic downturn but also to potentially expand operations.
How does this relate to tax planning? While businesses may have concerns about a recession, many of them are having a strong, profitable year. This means 2022 could be a critical tax planning year. Most businesses will want to accelerate deductions in 2022 to minimize their tax liability. This will allow them to hold onto cash instead of paying it to the IRS. Deductions have been less important over the last few years because of the low tax rates set in the Tax Cuts and Jobs Act of 2017 and concerns over potential tax increases. However, the combination of increased inflation and a looming recession makes deductions in 2022 more critical than ever.
For businesses and investors who own real estate, the most common way to accelerate deductions is through a cost segregation analysis. Such a study identifies the portions of a real estate investment that can be more accurately classified as equipment or land improvements and depreciated over five, seven or 15 years. With bonus depreciation at 100% for both new and used property, anything recognized in a cost segregation study can be deducted in the current year. This means businesses with real estate investments can utilize a cost segregation study to reduce their tax liability in 2022, then use this reduction to build up cash reserves going into 2023 to prepare for a potential recession.
Another reason to claim depreciation in a profitable year: Depreciation is considered an "accounting method," so an error in depreciation is corrected through a Form 3115 and not an amended return. Prior to the TCJA, a business could create a net operating loss and carry it back. However, the TCJA eliminated NOL carrybacks. Going into a recession, a taxpayer will want to maximize deductions in profitable years as those deductions may be less valuable if recessionary pressures force the business into a loss position.
Whether through a cost segregation study or another type of analysis, businesses would be wise to minimize tax liabilities in 2022. This will allow them to maximize cash reserves going into 2023 and to capitalize on opportunities that arise if recessionary pressures increase.
