All Forum Posts by: Paul Caputo

You should use MACRS, but that's easier said than done. As for your question straight line or double declining balance: You need to use both double declining balance and straight line as applicable for the property according to MACRS as well as some property uses 150% declining balance. The structural components of the building and those related to the general operation and maintenance of the building are part of the building and are depreciated over 27.5 years straight line for rental property. Most of everything else in the building is tangible personal property that is depreciated over 5, 7 or 15 years. The rules for what is what are very complex and sometimes counter-intuitive. (Example: Carpets are 5-year assets because they are easily removed and replaced, Tile floors are considered building components with a 27.5 year {or 39 year in commercial property} life because they are attached to the subfloor and not easily removed.)  The IRS says rental property and commercial property must be depreciated using MACRS, but they generally tolerate the impermissible 27.5 year straight line method for tangible personal property because they come out on top with that method since you overpay taxes in the present.

If the IRS is going to give you $100 for your tangible personal property depreciation would you rather get it accelerated over 5 years double declining balance: $40, $24, $14.40, $10.80, $10.80 then be fully depreciated at 5 years when you can either replace (and start depreciating the new assets) or continue use with no additional depreciation allowed OR depreciate your tangible personal property straight line over 27.5 years like the building: $3.63 per year for 27.5 years. Now scale those numbers up to your property and think about it: would you rather have a larger deduction and increased cash flow in the present or a smaller deduction and pay more taxes in the present? If you hold the property for its full depreciable life you will get the same amount of depreciation deductions using MACRS or straight line, but the timing of those deductions is different. On the other hand if you hold the property for less time, say 10-15 years, the difference in depreciation deductions can be quite significant. The crux of this is the time value of money, as your dollars are more valuable today than tomorrow (or 5, 10, 20 years down the road) so the more deductions you can take sooner the better. 

Put simply if you have a rental property with 10% tangible personal property and 90% structural components you depreciate 90% over 27.5 years straight line and 10% over 5 years double declining balance. The reality is its a lot more complicated than that. The IRS doesn't let you just say there's about 10% tangible personal property, you need to factually substantiate what is tangible personal property and what isn't. (Example: You have baseboards lining your walls, are they 5 year assets or 27.5 year assets? If they're tacked to the wall they're easily removed and replaced making them a 5 year asset, while if they're glued to the wall they're considered part of the wall making them a 27.5 year asset, unless the wall itself is a demountable partition that is easily removed and replaced making the wall a 5 year asset and the glued on baseboards are part of that 5 year asset. Now imagine that for everything in the building down to the nuts and bolts.) 

The best way to properly apply MACRS is an engineered cost segregation study per IRS guidelines. Depending on the size of the property it might not be cost effective to have a construction engineer breakdown the property to segregate costs, but that threshold is pretty low and the tax savings are often substantial. 

Most investors love the fact that they get depreciation deductions. Did you know that you may be incorrectly calculating your depreciation deductions costing you thousands in overpaid taxes? If you'd like to get back your overpaid taxes the IRS allows you to correct your depreciation deductions with an engineered cost segregation study. 

Segregation Holding is a specialized tax engineering firm made up of construction engineers and architects trained in cost segregation that exclusively perform engineered cost segregation studies. We work with you and your CPA to maximize your tax benefits through cost segregation. We perform these studies for all types of investors and business owners who own commercial property, rental property or leasehold improvements. 

Most commercial properties depreciate over 39 years, and rental properties depreciate over 27.5 years. Most investors depreciate the entire building using the straight line method over 39 or 27.5 years. Cost segregation allows building owners to separate out building components, personal property and land improvements and depreciate the building components at 39 or 27.5 years while depreciating the personal property at 5 or 7 years and land improvements at 15 years. If the building or improvements have been placed in service since January 1, 1987 the property generally qualifies for cost segregation. If the property was placed in service in a prior year the IRS allows you to take all the depreciation you would've had in prior years due to a catch up provision. These increased depreciation deductions can lower or eliminate federal income taxes or even result in a tax refund! 

We have worked with all types of investors and business owners from small real estate investors with rental properties under $100K to owners of large apartment complexes to restaurant owners to dental office owners to large manufacturing firms. We have completed over 13,700 studies since 2004 and have saved our clients billions in taxes. 

Segregation Holding guarantees at least $10,000 tax refund or tax credit resulting from our studies on properties over $200K cost basis less non-depreciable land value. We also guarantee a 500% ROI in tax savings vs our fee on properties over $500K cost basis (less land), and guarantee a 300% ROI on properties over $200K cost basis (less land). While we guarantee these minimum ROIs our clients enjoy an average 1276% ROI and we have never had to use our guarantees.

If you own commercial property, rental property or leasehold improvements with cost basis over $200K or even a portfolio of 5+ smaller properties please contact me for details on how cost segregation can help you get a large tax refund or tax credit!

On rental property your annual depreciation write off is 3.636%, on commercial property it's 2.564%. Since rental property is 27.5 year, 1/27.5 = 3.636% and on commercial its 39 year, 1/39 = 2.564%. So in that $100K rental property with $75K building your depreciation write off would actually be $2727. That brings your taxable income down to $1273. You could stop there or you could maximize depreciation with cost segregation. 

Cost seg breaks down the building into building components and personal property with rental property building components depreciating over 27.5 years straight line and personal property depreciating over 5, 7 or 15 years with 200% or 150% declining balance.

In the $100K example if 10% was reallocated to 5 year property through cost seg that's $7.5K depreciated over 5 years and $67.5K depreciated over 27.5 years. The 5 year property gets 200% declining balance depreciation so thats 40% depreciation in the first year declining after. So that's a $3000 depreciation write off in the first year declining after for the $7.5K personal property and a $2454 depreciation write off for the $67.5K building components. This shows your taxable income at a loss of $1454 in that first year, a loss of $254 in the second year,  an income of $466 in the third year, and so on until year 5 when the personal property is fully depreciated and you continue depreciating the building components at $2454 per year giving you a taxable income of $1546 in years 6-27.5 of ownership. 

It's a little complex as to be applied properly the study must be done by a construction engineer trained in cost seg and applying the hundreds of pages of tax code pertaining to depreciation. The great thing about cost seg is it allows you to catch up on prior year depreciation deductions that you missed so if you do cost seg 5 years after purchasing that $100K property you would have already had 5 years of $2727 depreciation deductions which would be converted into $2454 depreciation deduction for the building components and catch up depreciation of $6137 on the personal property to fully depreciate it since you already took $1363. That would give you a loss on taxable income of $4591 in that year and then go to $1546 taxable income as shown above. Going from a taxable income of $1237 to a loss of $4591 would be an income reduction of $5828 resulting in $2039 in tax savings in the current year assuming a 35% tax rate ($2307 at 39.6%).

This is a small example, but these numbers scale up and generally become more favorable with larger properties over $500K. Just to be clear cost seg does not create more depreciation, rather it front loads a portion of the depreciation resulting in a much larger deduction now with a decreased deduction later. In the example above there are much larger depreciation deductions in the first 5 years, with a slightly lower deduction in years 6-27.5 - $2727 entire building 27.5 year straight line vs $2454 building components 27.5 year straight line: a $246 annual depreciation reduction or about 9% less in later years.

How's that for a cash flow increase? Of course because of the engineering work and on site survey involved the cost of a study is high, but the tax benefits of accelerated depreciation far outweigh the cost of the study for most properties. Investors must also consider depreciation recapture upon sale of the property. If you are trading up when you sell you could use a 1031 exchange and avoid recapture altogether. 

I know you don't want to hear it, but ask a CPA that works with investors is the best thing to do since there are multiple things that can adjust the cost basis in a rental conversion. Depending on the difference in your purchase price and the current value you may want to look at using a business entity to own the home and adjust the cost basis to FMV.

My firm specializes in correcting depreciation deductions and the adjusted step up basis to FMV when it was placed in service is generally the cost basis in this scenario, but it depends on the situation and how you have everything setup. It's always better to speak to a professional and get it right rather than miss out on tax benefits or get a visit from the IRS.

If you really want to delve into your depreciation check out Pub 946 https://www.irs.gov/publications/p946/ch04.html after going through Pub 527. 

Your consultant is right about doing cost segregation on each building, but the cost may be lower than you would think and the benefits might be higher. It'd definitely be more than the $700 to your CPA for an engineered study which could cost $3K-$10K+. But if the study cost $3K and you get a $10K tax credit was it worth it? If the property was a little bigger and the study cost $5K and you get a $25K tax credit is that worth it? Of course it depends on your individual situation, but for most investors holding rental property or commercial property over 5 years the tax benefits of cost segregation studies are significant. 

I'm a cost segregation specialist so if you want to see some real numbers or have any questions about cost seg let me know.

You're absolutely right that the tax benefit of cost segregation represents a cash flow windfall for investors holding over 5 years, but it's a lot more complex than applying a few hours worth of information. A construction engineer trained in cost seg must perform the study, so the complexity and cost of applying cost segregation is why most investors don't do it even though they would receive a huge tax benefit. 

The most important things when considering cost seg are your cost benefit and that it's an engineered cost segregation study as opposed to a less intensive residual estimation or sampling study which can present IRS issues if too overzealous in reallocation. Back when the cost was $10,000-$25,000+ for a cost seg study it didn't make sense for a smaller building or rental property, but now the cost has come down considerably making it worth a look to every investor.

I'm a cost segregation specialist so if you'd like to learn more about the process or see some real numbers just let me know. 

Here's a little more info about using cost seg to maximize your deductions. 

If you want to maximize your depreciation deductions (And therefore maximize current cash flow: More deductions now means you keep more cash in your pocket now to reinvest while getting less deductions later on.) in the early years of ownership you should do a cost segregation study. 

Cost seg doesn't give you more depreciation overall, but it does accelerate it to give you a lot more depreciation now (On some assets in rental property it goes from a 3.636% deduction to a 40% deduction in the first year.) and in the next couple years as well as allow you to properly expense any component of the property upon replacement while starting depreciation on the replacement asset. 

For it to make sense to your bottom line you'd need to be holding for at least 5 years and your property should be over $200K less land value, so $250K total cost could be right depending on your land value. The tax benefit of a study depends on the overall cost of the depreciable property and the amount that can be classified for accelerated depreciation. 

On average an engineered cost segregation study will result in a tax credit of $25,000 for a $500K property. The main drawback is the cost of the study which is high because it is quite complex to properly classify every individual component in the property, and per IRS guidelines this must be done by a construction engineer or architect because of their expertise in construction techniques, design, auditing and estimating in building construction. 

If you'd like to know what your tax refund could look like with an engineered cost segregation study I'd be happy to take a look and answer any questions about cost seg.

Hi @Jeff B. you are correct in the definition of cost segregation, but a CPA is generally not qualified to do a cost segregation study unless they have construction engineers on staff. Per IRS guidelines only qualified individuals with knowledge of building construction, design, auditing and estimating procedures can perform cost segregation studies. Generally only construction engineers and architects have the necessary qualifications. 

A CPA can absolutely provide guidance on depreciation rates, but having an unqualified individual do a cost segregation study could lead to IRS issues. 

Hi @Larry Watson, a true cost segregation cannot be done with a simple excel spreadsheet. A true cost segregation study requires a construction engineer, and it can take 4-6 weeks to put together the  study. I wouldn't recommend putting together one on a spreadsheet yourself as that would be indefensible in an IRS Audit. I'm a cost segregation specialist so if you'd like more info on engineered cost segregation studies just let me know.