All Forum Posts by: Rohullah Sharifi

→ Form 3115, Application for Change in Accounting Method

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  This form lets you “catch up” all previously unclaimed depreciation in one shot.

  
  
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  You take a §481(a) adjustment (a lump-sum deduction) on your current year’s Schedule E. It can often create a large deduction in the current year, which is perfectly legal if done correctly.

A cost segregation study can be useful if you plan to hold the property long term, as it accelerates depreciation and boosts cash flow. However, it’s not free money—you’ll face depreciation recapture when selling, which reduces your basis and increases taxable gain. If you’re not in a high tax bracket or only have rental income, the benefit may be limited.

You should contact your accountant, as they can help you address the missed depreciation properly. When depreciation hasn’t been claimed in prior years, the IRS does not allow you to simply go back and amend all those returns. Instead, your accountant can file Form 3115 (Application for Change in Accounting Method) to request an adjustment.

This form allows you to "catch up" all previously unclaimed depreciation in the current tax year through what’s called a Section 481(a) adjustment. Essentially, it corrects your depreciation schedule and ensures you receive the full deduction you’re entitled to—without having to amend past returns.

So, in short:

• Your accountant will file Form 3115.

• The form adjusts your accounting method to include the missed depreciation.

• You get a catch-up deduction this year for all prior unclaimed depreciation.

A 1031 exchange is a powerful tool for deferring capital gains taxes when selling and reinvesting in a new property. By transitioning the replacement property into a short-term rental (STR), investors can potentially generate higher cash flow. Conducting a cost segregation study further accelerates depreciation deductions, reducing taxable income in the early years.

If the investor has suspended or carried-forward passive losses, these may be applied to offset rental income, enhancing tax efficiency. Importantly, the 1031 exchange also defers depreciation recapture, which would otherwise be taxable upon sale. By continuing to exchange properties and ultimately passing them to heirs, investors can benefit from the step-up in basis at death—effectively eliminating deferred capital gains and depreciation recapture taxes altogether.

I would recommend gaining a clearer understanding of how cost segregation works and how it aligns with your overall tax planning strategy. When applied appropriately, it can be a powerful tool to accelerate depreciation and improve cash flow.

There are several reputable firms that specialize in cost segregation studies. Engaging with an experienced provider can help ensure the study is thorough, IRS-compliant, and tailored to your specific property and financial situation

The involvement of a qualified tax professional is essential to ensure that taxpayers navigate the process accurately, efficiently, and in compliance with current tax laws. It helps prevent reliance on unverified or unsupported claims, which are often circulated by unlicensed individuals or through social media.

Unfortunately, if a taxpayer falls victim to misinformation or fraudulent schemes promoted online, there can be serious financial and legal consequences. That’s why professional guidance is not just helpful — it’s a critical safeguard.

I would recommend considering cost segregation on the new building rather than the current one. Since the cost basis of the new property will be higher, the potential depreciation benefits from cost segregation will also be greater.

If you proceed with cost segregation on the current property now and subject to depreciation recapture, which could reduce your adjusted basis and potentially increase your tax liability upon sale.

Timing and property selection are important when applying this strategy, so it may be more beneficial to wait and implement it on the new acquisition.

Good luck with your plans moving forward. If financially feasible, I would recommend considering investments in both short-term rentals (STR) and long-term rentals (LTR), as each can offer distinct advantages for building wealth and diversifying income.

If you're currently in a high-income bracket, you may benefit from conducting a cost segregation study on rental properties to accelerate depreciation and reduce your taxable income in the near term.

Additionally, you might want to consider:

• Establishing an LLC, potentially in joint ownership with your spouse (if married), which can provide liability protection and potential tax flexibility.

• Rolling over your 401(k) into a self-directed IRA (SDIRA), which would allow you to invest retirement funds into real estate and potentially gain additional tax-deferred or tax-free growth, depending on the account structure.

However, because you are now planning to move into the property and use it as your primary residence, the option to apply cost segregation is no longer available. Cost segregation is a tax strategy that accelerates depreciation for investment or rental properties, but it is only applicable while the property is being used for rental or business purposes.

Once the property is converted to personal use, depreciation (and by extension, cost segregation benefits) must stop. If you wish to take advantage of cost segregation, the property would need to remain a rental for the foreseeable future.

Please let me know if you’d like to discuss the tax implications further or explore other planning options.

I recommend structuring your real estate operations to include short-term rentals (STR), some property flips, and long-term rental investments. The income and profits generated from STRs and flips can be strategically used to support and grow your long-term rental portfolio.

However, I do not recommend using an S Corporation for holding rental properties, as it is generally not well-suited for long-term real estate investments. S Corps present limitations in terms of tax flexibility, property transfers, and passive income treatment, making them a less favorable option compared to structures like LLCs.