Ah yes, the wonderful life of a real estate investor. In between the passive income generated and tenants calling you at midnight complaining about broken heaters, there is one savvy tax savings strategy that is often misunderstood—or just plain unheard of.
But the end result of this strategy can yield upfront cash flow faster for investors and help reduce your current tax liability at the same time. Do I have your attention yet?
If you’re ready to hold onto more of your hard-earned cash, say hello to cost segregation.
What is Cost Segregation?
Cost segregation is a tax planning strategy used by real estate investors that accelerates the depreciation of certain components of their properties. This amounts to a reduction in your current tax liability, resulting in upfront cash flow.
How exactly does it work? According to the IRS, a building normally depreciates its value over 39 years (non-residential) or 27.5 years (residential).
So, let’s say you own a residential rental property. Without cost segregation, your property would be depreciated consistently (known as “straight line”) over 27.5 years.
Sure, that’s great and all, but everyone knows that most components, like carpeting, landscaping, appliances, and cabinetry, don’t last 27.5 years—particularly in rentals.
With cost segregation, you can reclassify a portion of your assets as personal property instead of real estate property in order to depreciate them on a much, much faster schedule (such as five, seven, or 15 years) for tax purposes. This lessens your tax burden, thereby leaving you with more profit.
What Are The Financial Benefits Of Cost Segregation?
Put simply, offsetting passive income through accelerated depreciation!
Below is a before and after scenario for Joe the Real Estate Investor:
Almost $5,000 in tax savings? Not too bad if you ask me!
How did I calculate that? Depreciation is an expense against income, like operating expenses. With the $33,791 in depreciation captured through cost segregation, Joe was able to claim that total as a loss, thus reducing his total taxable income even further to $1,209 versus $23,706.
Why Cost Segregation is More Beneficial Now Than Ever
With the enactment of the Tax Cuts and Jobs Act (TCJA) of 2017, we saw an increase in first-year bonus depreciation from 50 to 100 percent. With that said, I cannot stress how much more valuable cost segregation is to real estate investors. A cost segregation study will help you determine which assets qualify for 100 percent bonus depreciation.
It is important to note that not all assets will pass the test. To be eligible, assets must have a tax recovery period of 20 years or less. Additionally, used property must have been acquired and placed in service on or after Sept. 28, 2017, and before Jan. 1, 2023.
If you’re ready to reduce your current tax liability and take advantage of this “gem” of a strategy, make sure to check with your CPA beforehand to ensure cost segregation makes financial sense for you.
Then when you’re ready, find a reputable company who does cost segregation utilizing the engineering approach. According to the IRS, this approach is considered the most accurate and defensible. Better to be safe than sorry!
Do you understand the changes that came with the TCJA of 2017 with regard to cost segregation? Any follow-up questions for me?