Business Management

Cost Segregation: How Real Estate Investors Pay Less in Taxes

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10 Articles Written
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Disclaimer: This is designed to provide general information regarding the subject matter covered. It is not intended to serve as legal, tax, or other financial advice related to individual situations. Consult with your own lending professional, attorney, CPA, and/or other advisor regarding your specific situation.

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Taking advantage of depreciation on investments is a time-tested wealth preservation tool. Cost segregation studies are one method for investors to increase depreciation on their investments and reduce their tax burden.

There has been some concern in the investment community about how federal tax reform might affect cost segregation studies (1) and impact investments, but to date the studies remain a useful tool for investors and there are no indications that this will change.

Before engaging in cost segregation studies, however, investors should understand what the term means, how the process works, and whether it’s the best option for their particular investment profile.

What Is Cost Segregation?

Cost segregation is a common accounting tool used by investors as a capital-preservation instrument. These studies are an IRS-approved way to realize tax benefits by reclassifying assets to achieve accelerated depreciation.

For real estate investors, cost segregation can be used to reduce the taxes paid on rental income and increase the cash flow of a property. Usually completed by qualified engineers and CPAs, cost segregation studies generally take two to four weeks to complete, so experts advise investors planning to do them to begin studies on a property as soon as it is purchased, built, or redeveloped in order to begin reaping the benefits of this tool.

Related: Think Cost Segregation Is Too Expensive? Here’s Why You’re Wrong

How Does Cost Segregation Work?

Commercial or residential property typically depreciates over 39 years or 27.5 years, respectively, while personal property or land improvements typically depreciate over five, seven, or 15 years. Cost segregation reclassifies certain elements of a building to personal property or land improvements, so that they depreciate within a shorter time period than the building as a whole.

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The Tax Cuts and Jobs Act of 2017 made it possible for 100 percent bonus depreciation to be taken in the first year for used personal property placed into service after September 27, 2017. Therefore, using cost segregation on real estate investments accelerates depreciation on those investments, resulting in greater tax savings for investors.

The building will still depreciate at the normal rate and land cannot depreciate, but the tax savings can still be significant for investors.

Does Cost Segregation Make Sense for You?

As tempting as it sounds to embark on the cost segregation process, these studies are not right for every investor or every property.

Studies can be costly, and you might not recoup expenditures in tax savings on depreciation or in recapture upon sale (since capital gains taxes may apply).

Related: Cost Segregation Case Study: How to Boost Retirement Income Using Real Estate

Investors in large multifamily or commercial properties and those who hold properties long-term stand to benefit the most from cost segregation studies. However, investors who don’t fall into these categories may still benefit from them.

When it comes to cost segregation, the wisest approach is to consult a trusted tax professional who can advise on the process, including the pros and cons of these studies as related to a particular investment situation.

Sources

  1. https://www.accountingtoday.com/opinion/benefiting-from-cost-segregation-in-the-new-tax-reform-environment

Disclaimer: This is designed to provide general information regarding the subject matter covered. It is not intended to serve as legal, tax, or other financial advice related to individual situations. Consult with your own lending professional, attorney, CPA, and/or other advisor regarding your specific situation.

Do you have any follow-up questions for me about cost segregation? 

Ask me in a comment below.

Since founding Trion Properties, a private equity investment company that specializes primarily in value-add multifamily real estate investments and ground-up developments, Max Sharkansky has led the acquisition, renovation, and disposition of over $300 million in mismanaged and distressed assets. Max, along with partner Mitch Paskover, formed Trion in 2006 and successfully formulated a strategy of acquiring "diamond-in-the-rough" multifamily properties and creating value through renovations, creative rebrands, hands-on management, and the improvement of operating efficiencies. Max’s expertise of the marketplace has been instrumental in the firm’s success. Find out more about investing with Trion at Trion-Properties.com.

    Etser Edward
    Replied about 2 months ago
    I work for CSSI, we are a cost segregation firm. Contact me now for your now cost no obligation estimate so that we can show you how Cost Segregation can save you money, all you to put it in your pocket or back in your business. Email me [email protected] or contact 915-302-6150
    Alin Dev from Quincy, Massachusetts
    Replied about 2 months ago
    Max, thanks for the article. Question - after cost seg, can I expense a personal property, or does it still have to be depreciated (on a somewhat shorter time frame)? For example, when I bought a rental condo, it already had an oven in a rental unit. Lets say the cost seg assigns a value of $400 to the oven. Can I expense the oven as a deminimis expense, or does it have to be depreciated in the current year at 100%?