{"id":100181,"date":"2018-06-30T11:00:27","date_gmt":"2018-06-30T17:00:27","guid":{"rendered":"https:\/\/www.biggerpockets.com\/renewsblog\/?p=100181"},"modified":"2021-03-16T13:57:45","modified_gmt":"2021-03-16T19:57:45","slug":"cost-segregation-why-give-your-money-to-the-irs-when-they-let-you-keep-it","status":"publish","type":"post","link":"https:\/\/www.biggerpockets.com\/blog\/cost-segregation-why-give-your-money-to-the-irs-when-they-let-you-keep-it","title":{"rendered":"Why Give Your Money to the IRS When You Could Keep it?"},"content":{"rendered":"

Do you own an investment property valued at $1,000,000 or more?<\/span><\/p>\n

Do you pay federal income taxes?<\/span><\/p>\n

Do you operate a corporation or entity that is for-profit?<\/span><\/p>\n

Are you planning to the hold the property for more than one year?<\/span><\/p>\n

If you answered yes to all of these questions, you are eligible to enter a raffle that will be held at the end of this article. <\/span><\/p>\n

Just kidding. But you are eligible for major tax benefits, so keep reading. <\/span><\/p>\n

You already know that real estate is the best industry to be in, but \u00a0you\u2019re about to learn that it\u2019s even better than you thought. Why? Because of all the tax perks that come along with it.<\/span><\/p>\n

What is Depreciation?<\/h2>\n

It’s one of the best gifts Uncle Sam gave to property owners and real estate investors. Depreciation is a special tax deduction based on the concept that the more something is used, the lower its value goes. When you drive a new car off the lot, it immediately goes down in value. It\u2019s the same with real estate. Every year, the IRS allows you to take a deduction of the property value against that loss in value. (This does not include the value of the land, which doesn\u2019t depreciate each year). But here\u2019s the best part \u2014 this applies even if your property value is <\/span>appreciating <\/span><\/i>each year!<\/span><\/p>\n

Related:<\/strong>\u00a0How to Use Cost Segregation to Increase Annual Depreciation (& Save Money!)<\/a><\/em><\/p>\n

Simply put, depreciation is a paper write off for real estate. <\/span><\/p>\n

OK, so I understand what depreciation is. And I know that a residential property is depreciated over 27.5 years\u2014and a commercial over 39. But what does it mean to <\/span>accelerate<\/span><\/i> that depreciation?<\/span><\/p>\n

These are very long periods of time. To make the benefits of depreciation more tangible, the IRS established shorter \u201clives,\u201d as follows: <\/span><\/p>\n

    \n
  1. Five years for personal property within the building (flooring, boilers, etc.)<\/span><\/li>\n
  2. Fifteen years for \u2018land improvements\u201d outside the building.<\/span><\/li>\n
  3. The standard 27.5\/39 year rate for the structure of the actual building.<\/span><\/li>\n<\/ol>\n

    What does this mean for you? You can depreciate the value of the first two categories of assets at a faster rate and start saving on taxes during those first few years after purchase. These savings you can reinvest in other ventures. <\/span><\/p>\n

    How Much of a Property Can Generally be Re-classified Through Cost Segregation?<\/h2>\n

    Usually between 10 percent and 30 percent of the property value.<\/span><\/p>\n

    OK, so let\u2019s make sure I understand this completely. What are some examples of five-year personal property?<\/span><\/p>\n

    Flooring, carpeting, wall coverings, appliances, furnishings, special purpose lighting, special purpose plumbing, special purpose electric, and much more.<\/span><\/p>\n

    What are examples of 15 year property\u00a0 land improvements?<\/span><\/p>\n

    Asphalt, fencing, landscaping, signage, etc.<\/span><\/p>\n

    Wait. So, all these years I\u2019ve been willingly lending the IRS my money when I could have possibly lowered my tax liability to ZERO?<\/em><\/p>\n

    Umm…yes. But you can stop today!<\/span><\/p>\n

    Now comes my most important question:<\/p>\n

    Why Didn\u2019t my Accountant Tell me About This?<\/h2>\n

    A CPA isn\u2019t qualified to perform cost segregation<\/a>. Tax knowledge is not enough. You also need to understand engineering to calculate how each structure depreciates. That\u2019s why there are cost segregation firms \u2013 which employ engineers that are trained in the tax code and tax experts who work together to conduct the cost segregation study. \u00a0<\/span><\/p>\n

    Your CPA can certainly apply the results once the cost segregation study is complete. But the IRS recommends (not requires) that those \u201ccompetent in construction methodology or techniques\u201d perform the actual study determining how much you can save. <\/span><\/p>\n

    Who Works at These Firms, if Not Accountants?<\/h2>\n

    The firms hire engineers that are trained in the tax code and<\/em> tax experts, and they work together to conduct the cost segregation study according the Cost Segregation Audit Techniques Guide from the IRS.<\/span><\/p>\n

    But you can\u2019t just make claims. Everything has to be documented: what you built, when it was built, and how much you paid for it. The construction budget or the AIA (American Institute of Architects) documents will be used during the study. <\/span><\/p>\n

    Does This Mean That Certain Materials and Building Methods Can Save me More Money?<\/h2>\n

    Yes. The materials used and how they are affixed make a difference in whether the property is considered a five-year property. As we said above, if something is part of the main structure, it is not personal property and can\u2019t be accelerated.<\/span><\/p>\n

    \"\"<\/p>\n

    What Are Some Common Examples of Things That Could be Eligible if Done Properly?<\/h2>\n

    Floor coverings \u2014 if it\u2019s affixed with permanent adhesive, nailed, or screwed, then it\u2019s considered part of the structure.<\/span><\/p>\n

    Not eligible:<\/strong> ceramic tile, marble, paving brick, or permanent wood floors.<\/span><\/p>\n

    Eligible:<\/strong> strippable adhesives such as vinyl-composition tile, sheet vinyl, carpeting, and floating hardwood floors.<\/span><\/p>\n

    Should I Have Cost Segregation in Mind Already as Soon as I Start Building or Renovating?<\/h2>\n

    You should. A savvy real estate professional will keep this in mind.<\/span><\/p>\n

    Related:<\/strong>\u00a0Your Tax Write-Offs Could Affect Your Ability to Get a Loan: Here\u2019s How<\/a><\/em><\/p>\n

    What are Other Examples of Things That Could be Eligible?<\/h2>\n