Cost segregation Study-Worth it???

[John Matthew Johnston]

Hi we currently own 8 SFR's, 1 Duplex, 2 Commercial buildings and a 4 plex. We bought all these since 2019. I understand the basics of a CSS but I was wondering if it would be worth the squeeze? We have made significant improvements to all the properties. We plan to hold the properties long term. I hold mortgages on almost all the properties and the portfolio is probably worth close to 2.2m and we have around 1Mil in equity.

[Sean Culloden]

When you’re thinking about doing a cost segregation study, the first thing to figure out is what income you’re trying to offset. A cost seg is a timing strategy, so it only provides value if there’s income it can be applied against.

That income can be either passive or non-passive. Rental real estate is passive by default, so if you already have taxable passive income from your properties, cost segregation is often the most straightforward win because accelerated depreciation can directly offset that income.

If instead the goal is to offset non-passive income like your 95k salary, you need to determine whether the rental activity can be treated as non-passive. That generally means qualifying for either Real Estate Professional status or the short-term rental exception.

With a full-time nursing job, qualifying as a real estate professional is unfortunately not realistic since it requires more than 750 hours and more than half of your total working time to be spent in real estate activities. Without REP or another exception, additional depreciation from a cost segregation study will not reduce W-2 taxes. Those losses simply carry forward until you have passive income or eventually sell the properties.

The main exception to this is if any of the properties qualify as short-term rentals with an average stay of seven days or less and you materially participate. In that case, the losses can be treated as non-passive and can offset W2 income.

Once you’ve identified the type of income you have and what you’re trying to offset, you can then run the numbers to see if accelerating depreciation today makes financial sense. Higher marginal tax brackets generally increase the value of cost segregation, while lower brackets reduce the immediate benefit. As @Bob Solak pointed out, having less deprecation available in the future and depreciation recapture upon sale also needs to be factored into the analysis as well.