Real estate investors have more opportunities than ever before to maximize tax savings by using a cost segregation study as part of their year-end tax planning strategy.
A cost segregation study is an analysis in which an engineer identifies and examines the various components of a building in order to report and categorize the personal property separately from the real property. The separation of personal property from real property allows for the taxpayer to apply shorter depreciable lives to the personal property component of the building. In some cases, these assets may even be eligible for federal accelerated bonus depreciation. Examples of personal property that can be classified into shorter depreciable lives include kitchen cabinets and countertops, appliances, flooring, patio/deck, and fencing.
Historically, properties with a depreciable tax basis of $1,000,000 (purchase price less land) or more were considered good candidates for cost segregation studies. However, with increased efficiencies from leveraging technology through historical trends and data, it is now possible that a rental home, condominium, townhome or apartment complex with up to six units with a depreciable tax basis of $500,000 or less may also be a good candidate for a cost segregation study.
The tax benefits from cost segregation studies vary depending on the attributes of the property; however, typically 30% of the personal property can be carved out from the real property. This results in tax savings in the initial year the property is placed in service. If a cost segregation study is not performed in the year placed in service, it still may be beneficial to perform the study in a subsequent year, since the rules allow for a “catch up” of depreciation expense.
Beyond creating additional deductions through accelerated depreciation, it is also relevant to discuss the utilization of these benefits. In addition to considerations in determining the best candidates for a cost segregation study based on the property attributes, the taxpayer’s overall status must be also be addressed. Taxpayers who are active in the management of their property, or passive investors with other passive income, will benefit most from the acceleration of depreciation on qualified property. This allows taxpayers to utilize the full benefit of the additional depreciation deductions against other items of income, or sources of passive income created from additional investments.