Cost Segregation? Worth it?

Question

I've been hearing the hype about Cost Segregation for a while and I wasn't sure i was a candidate. Still not. My w2 income wont be over $100k for 2022, I will hopefully be considered a RE professional and i had 5 properties, some already in the red due to rennovations.  But a provider did a prelim estimate for me and it says that for my 5 properties i'd have increased depreciation of $177k and estimated tax savings in year 1 of $68k.  Its just an "estimate" but i'm sure i'm supposed be wooed by it.  Do these "free estimates" usually come out close to the truth and if so, do those numbers make sense for someone in my situation? I heard you could carry the the depreciation forward if you don't use it all but i'm not clear the dollar for dollar value.  Are they saying i truly pay $68k less over time if i simply give them $18k today? what if my income is lower in future years? What do I need to consider that i'm not? Any advise is welcome! Thanks

Chelsea Monk · Answer

They're coming up with a ~38% tax bracket. Given that CA doesn't conform to federal bonus depreciation rules, you'd be looking at a max tax bracket of 24% fed and 9.3% state, so already their estimate is high. Then consider that you're not a RE professional (unless your work in RE accounts for more than 50% of your money-making time AND is more than 750 hours), and your losses are limited to $25k max, less if the rest of your income is over $100k. So max savings in a single tax year would be ~$8500, bearing in mind that you'd be offsetting any rental profits with the losses generated by the cost seg study, so potentially just a smidge higher on the federal side. And also bear in mind that the state savings may actually be less since you'll have to depreciate all class lives over their actual life and not up front.

Does it make sense for you? Maybe. I've recommended similar. But you'd need to sit down with your accountant and run projections to see the pros and cons, including what you expect income to look like in future years and your plans for your properties.

Does it make sense for you? Maybe. I've recommended similar. But you'd need to sit down with your accountant and run projections to see the pros and cons, including what you expect income to look like in future years and your plans for your properties.

Michael Plaks · Answer

@Wendy Stclair

If you have a regular 40-hr W2 job, you will not qualify as a Real Estate Professional. If you have a spouse, maybe your spouse can qualify. Otherwise, no luck.

Your available losses, combined for all 5 properties, will be limited to $25k per year, and it is possible (even likely) that cost segregation is not helpful in your case. To be certain, get your own tax professional experienced in real estate and cost segregation and have them assess your specific tax situation. It's case by case, unlike those generic estimates of potential savings that you're talking about.

Read this post, it should be helpful: https://www.biggerpockets.com/forums/51/topics/1075919-five-common-myths-of-cost-segregation-and-100-bonus-depreciation

Jon Fletcher · Answer

Short Term Rentals are considered "active income." Therefore, by creating a loss through depreciation, you are creating an "active loss" that can offset against all of your active income, including W-2 income. This differs from Long Term Rentals, which are considered "passive income" with "passive losses" that can only be offset against other passive investment income. FYI - I'm not a CPA.

Basit Siddiqi · Answer

The estimated tax savings that these cost segregation companies provide are normally invalid as they don't know your whole picture.For example, the tax savings of $68,000 is laughable.Your income of about $100,000 is likely going to be taxed somewhere in the 22% tax bracket(Unsure of your tax filing status).Which would mean, even if you can take 100% of the losses, that your savings would be around $22,000.There are two different types of cost segregation studies - Studies where Engineers are stopping by the property and creating a report for you - Starts at $2,500Studies based on completing a questionnaire - Starts at $450I normally recommend one study over another in certain situations.best of luck.

Tom O. · Answer

1. The cost segregation lady I spoke to did not say that at all re short term rentals. Can you explain why you believe only short termers can benefit?

2. You can't take losses from your passive income (rental) against your work income (active). I will be able to take it to offset capital gains but much of these "losses" will go away with depreciation recapture.

Jon Fletcher · Answer

@Tom O. my understanding is that the only way you can benefit from these accelerated depreciation losses is if you have a Short-Term Rental. Your decent day job won't prevent you from taking the losses against your W2 taxes. Seemingly, this is where the real benefit of bonus depreciation lies for full-time employees like ourselves.

Tom O. · Answer

I thought the benefit of cost segregation was increased losses due to depreciation of more things not changing whether you can use it against active income. (You can't according to my accountant.) So here I sit with $120K in "losses" mostly due to rehabs of units waiting for the day when I actually start taking profits. But I have a decent day job although retirement is in sight.

James Parrish · Answer

@Wendy Stclair

The threshold for RE professional status is typically more than 50% of your work hours have to be dedicated to real estate, those hours must also add up to 750 or more. There's a lot of nuance that goes into determining if a cost segregation makes sense for your situation, so utilizing a real estate specific CPA is crucial. A quality cost segregation company, with the correct information, will also tell you if this strategy makes sense or not.

Best of luck!

Julio Gonzalez · Answer

@Wendy Stclair If you don't have real estate professional status but your income is around $100k, you could deduct up to $25,000 in passive losses based on the passive activity loss limitation allowance which would still allow you to benefit from a cost segregation study. However, this is all dependent on various factors. Have you discussed this with your CPA? I'd recommend getting quotes from a few cost segregation companies and then taking those to your CPA to determine if you could benefit from one.

Cost Segregation? Worth it?

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