How to Maximize the Tax Benefits of Real Estate With Cost Segregation Studies
One of the things that surprise newer real estate investors is the fact that their investment can be depreciated in order to gain tax benefits. In this article we explain depreciation, however, today we’re going to talk about a strategy not as commonly known: cost segregation.
What accredited and sophisticated real estate investors know is that every dime you invest in real estate can be optimized. It can be the difference between having a mildly successful or wildly successful investment.
And this is where cost segregation comes in. It is one of the best strategies to accelerate the tax benefits from your investment, by adjusting the depreciation of different elements of the property at different rates.
Why Would Anybody Want to Speed up the Depreciation of His or Her Investment?
In this article, we explained how real estate depreciation happens when the value of the property lowers over time.
But rental income from real estate is taxed differently from the active income from your day job. As an apartment building ages, not just the building structure can be depreciated, but also the contents of the building (yes, everything right down to the kitchen sink). Depreciating your assets can result in paying fewer taxes on the income earned from this and other passive investments.
What Is Cost Segregation?
Cost segregation is a strategy to reduce the taxable income of real estate by accelerating its depreciation deductions and deferring federal and state income taxes. This is done by having a cost segregation study done on the asset.
The way it works is that, according to the IRS ruling, a residential property depreciates in 27.5 years, while a commercial property does it in 39 years. But with cost segregation, you can speed up this process, by separating the building structure from its interior and exterior components that typically depreciate at a much faster rate.
How Is a Cost Segregation Study Done?
A professional with experience in engineering and taxes does a study of each component of the property and categorizes them into their most tax-efficient categories. Things like:
Heating & cooling systems
Carpeting
Cabinets
Storage tanks
Millwork
Wallcoverings
Parking lots
Kitchen equipment
Electrical system
Plumbing
What Are the Benefits of Cost Segregation?
A cost segregation will allow for accelerated depreciation and reduced income tax payouts.
All the internal and external components of a building (besides the building itself and the land) can be classified as tangible personal property, which depreciates at a much faster rate than the whole property. While residential property depreciates in 27.5 years and commercial property does in 39 years, these separate items can depreciate in 5, 7, or 15 years. Sometimes they can even be expensed, which will mean more cash from your property actually staying with you.
A complete cost segregation study will also provide a detailed report of structural components like the roof, windows or heating, ventilation, and air conditioning units (HVAC), which can be claimed as loss deduction when they are replaced.
When Should a Cost Segregation Study Be Done?
While it can be done anytime after a purchase, a cost segregation study will have its most impact if done during the first year after acquiring the building.
This is because of the current most powerful benefit of a cost segregation study. According to the Tax Cut and Jobs Act of 2017 (TCJA), personal property that has been acquired after Sept. 27, 2017 is eligible for 100% bonus depreciation. This means that during the first year the qualified assets that depreciate in 5, 7, and 15 years, can be deducted by 100%. This is a huge amount in taxes saved all due to the cost segregation study.
Who Should Do a Cost Segregation Study?
While the benefits are incredible, not everyone will be able to capitalize on them. A cost segregation study can cost tens of thousands of dollars, and only if the tax benefit exceeds the initial investment should the study be done. This is why cost segregation studies are usually done on commercial real estate and multifamily properties.
Even Greater Tax Benefits From Real Estate
If you’d like access to reliable deals that offer the opportunity of tax benefits plus passive income, then Titanium Investments has you covered.
We make investing in tax-reducing deals easy and stress-free for our investors while providing passive income to enjoy the life you've always dreamed of. Schedule a call today with one of our real estate advisors here.