Cost Segregation: What Real Estate Investors Should Know

Are you a real estate investor with numerous properties, who fears tax season? This may be the year for you to utilize cost segregation and kick that fear to the curb.

Cost segregation can save real estate investors tens of thousands of dollars in taxes every year. This tax-saving strategy utilizes your real estate’s depreciation as a loss to significantly lower what you owe on taxes at the end of the year. It is especially useful for those who have newly constructed property of real estate valued at over $1 million.

Using cost segregation to your advantage can be done with the help of an experienced tax preparer, a cost segregation study team, and this helpful guide. Let’s get started.

What Is Cost Segregation?

Cost segregation studies bring qualified engineers onto your property to reclassify depreciating building components. These components can be everything from flooring to home appliances. The goal of the study is to identify all property-related costs.

Normally, commercial properties will depreciate over 39 years while residential ones depreciate over 27.5 years. Personal property and land improvements depreciate over 5,7, or 15 years. The land itself does not depreciate.

The important thing to note is that cost segregation is a reallocation of property assets. Some of these assets will be able to classify into 5-, 7-, or 15-year depreciation values, while others will remain at the 39- or 27.5-year mark.

As the cost segregation team analyzes your properties, they will apply certain tax codes to the differing depreciating parts of your real estate. After calculating the total depreciation value of all assets, they will divide the total depreciation into an annual sum. These annual depreciation costs then transfer into a filed loss on your taxes, lowering the total income you must pay taxes on.

The Tax Cuts and Jobs Act

The Tax Cut and Jobs Act is a beneficial law for real estate investors. It affects all property placed into service after September 27, 2017. Unfortunately, for many real estate investors, it will only remain in place until the end of 2022. After this, the Act will slowly phase out.

This Act is beneficial because it allows real estate investors to take a bonus depreciation of 100% for certain qualified assets over the first year, as opposed to spreading the depreciation over more years.

How Cost Segregation Can Help

Many people would wonder why they would break down their property into such small parts when they could instead depreciate the entire building over time. After all, the latter is much easier, isn’t it?

Yes, it is, but it isn’t more beneficial for the property owner.

Let’s imagine that you purchase a $2 million office building. Since it’s commercial, it depreciates over 39 years. Assuming you are in the 30% tax bracket, you could save roughly $7,700 annually when simply counting the overall depreciation of your property.

Instead, let’s imagine that you take the calculated risk of paying for a cost segregation study. The experienced engineers and our tax preparers can calculate that half of the value of your building can be classified as assets that depreciate over a 5-year term – that’s quite a jump from the 39-year mark you were initially working with.

In this case, that 50% of assets equals $500,000, meaning half a million dollars is put on a 5-year depreciation schedule at that same tax rate of 30%. Suddenly, you are saving up to an extra $30,000 annually for the first 5 years that you own this property.

Say hello to more than $22,000 in savings per year compared to the traditional depreciation method you used to use.

Who Should Use Cost Segregation?

A cost segregation study can cost between $5,000-$15,000 per property depending on the size. While this may seem like a hefty lump sum at first, it could end up saving you tens of thousands of dollars in taxes if done right.

Now, these savings aren’t for small-time real estate investors who own a couple of single-family dwellings. If you’re going to shell out the cash for the cost segregation studies, you should make them count by using them on large, new real estate acquisitions, especially those valued at over $1 million.

Final Thoughts

Cost segregation can take the depreciation value of your property and reclassify it into distinct parts, following a tax loophole that could save you thousands. If you pay for a cost segregation study before the end of 2022, you could also take advantage of the Tax Cut and Jobs Act to expand these savings exponentially.

Speak with our experienced tax preparers to discuss how cost segregation can help you save money on your taxes. With real estate opportunities abounding, there’s no time to waste when it comes to saving tax money to fund a new deal.

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Robert Hall and Associates Tax Consultants