Category: Cost Segregation

Cost segregation study has become a very important strategy to reduce taxes among real estate investors. When done right, an investor could save hundreds of thousands of dollars in taxes. That’s the thing, it has to be done right.

Cost segregation is the acceleration of the depreciation of assets. The definition alone could really hurt one’s brain, especially if they are not experts on the matter. The confusion over the complexity of cost segregation study has led to some misconceptions.

Check out some of the myths about cost segregation:

Multifamily housing property depreciates over 39 years

Actually, it’s the non-residential properties that get depreciated over 39 years. For residential buildings, as in the case of multifamily housing properties or apartment complexes or condominiums, the depreciation is only over 27.5 years.

That’s more than a decade difference that could really affect the cost segregation study. Residential properties are depreciated using the straight-line method along with the mid-month convention.

But what constitutes a residential rental property? This is an important question since there are a lot of buildings that have both the residential and commercial sectors. To be considered as residential rental property, at least 80% of the gross income should come from residential rents.

Apartment complex improvements are covered under the QIP

Qualified improvement property or QIP refers to non-residential buildings. There are four categories under the QIP:

1. Qualified improvement property
2. Qualified leasehold improvement property
3. Qualified retail improvement property
4. Qualified restaurant improvement property

What is the importance of knowing these categories? This is because the Tax Cut and Jobs Act of 2017 amended the previous provision that expensing would include tangible personal property. The amendment clarifies what are covered in the QIP.

Specifically, those covered include the roofing, heating, air conditioning and ventilation, alarm and security systems. However, adding extension to the building is not covered. Other improvements that are not considered in the QIP are elevator and escalator, internal framework of the building as well as the exterior.

39-year depreciation is always terrible

This is not necessarily true. It could be true, but it’s not always true. This is particularly note-worthy among owners of mixed-use buildings. Here’s the deal: When the building’s commercial establishments are less than 20% of the occupancy, there is no effect on revenue test. This is because the revenue test looks at the revenue, as the name implies, and not on occupancy.

This way, when QIP is imposed, it would be to the owner’s advantage especially when there have been improvements or when there is a plan to make some improvements. This could push the owner to benefit from the 100% bonus depreciation covered under the QIP.

Owners, though, would have to identify structures or certain structural parts of the construction projects that would have to maintain the 39-year depreciation.

For the untrained eye, everything mentioned would seem very complex indeed. One could greatly benefit from getting a specialist to study the properties and assets in order to maximize the benefits of the cost segregation study and not fall for the common myths.

With coronavirus still raging on, the economy is yet to stabilize. Thousands of people lost their jobs and most businesses have really been in trouble. Real estate is not doing good either. With people’s livelihoods in trouble, buying or investing in real estate is the last thing on their mind right now.

This is why it is essential for real estate investors to be really practical with their money. They have to be frugal and smart. One way to really make a dent in the cash flow is to reduce taxes. Real estate investors who may not have been meticulous with their taxes before should now be looking for ways to benefit from the tax rules.

A good way to reduce taxes is by maximizing the benefits of depreciation. Every asset has a useful life, which is the estimated number of years by which this will serve its purpose for the business. In essence, every year, the useful life decreases. That’s when depreciation comes in and lowers a taxpayer’s taxable income.

Cost segregation

The process by which a taxpayer imposes the depreciation of assets is called cost segregation study. This strategy accelerates the depreciation of assets n order to lower taxable income.

To be more specific about it, a multi-family property, for example, has a depreciation schedule of 27.5 years. With cost segregation study, a taxpayer can separate the property’s assets to have a much faster depreciation. The assets, minus the lot, could have depreciations of five, seven and 13 years. In some cases, the tax benefit could be over a million dollars.

However, cost segregation study should be done right for real property investors to really reap the benefits. The best way is to hire an expert like a cost segregation specialist. An expert could really take a look at one’s property and assess every asset that could aid the reduction of tax. While hiring a specialist will cost money, the savings that will result from it is so much more.

Bonus depreciation

Couple the cost segregation study with bonus segregation and it could really turn one’s financial woes around. The Tax Cuts and Jobs Act of 2017 includes a provision on bonus deprecation. It has always been available but only for new developments. The law allows the same strategy for new purchases.

But what exactly is this? It is a provision that allows real estate investors to get 50% to 100% depreciation during the first year as long as the asset has a useful life of less than 20 years. Although, this strategy can only be used for real properties used for business and not for personal properties.

It really pays that people understand how taxes work and the strategies that will allow them to save money by reducing tax. For those people who are still confused, there are experts that can help them with both cost segregation study and bonus depreciation. Basically, if one is reducing their taxes, then they are essentially increasing cash flow.

The main benefit that you should know about cost segregation is accelerated depreciation. For outsiders, that may not sound right. No one wants depreciation, especially when accelerated. But in this instance, we are talking about depreciation of income property for tax purposes. Now, tax and depreciation sound good together. 

You should know, you will save a lot of money when you employ cost segregation. It’s hard to give a number to it considering that these would refer to different numbers. What you save from cost segregation will largely depend on the total amount of the assets. 

This is probably the only time when we like to hear the word depreciation of the property. Depreciation refers to the reduction of the value of an asset. When you are selling a property, then depreciation isn’t too good as this means that you will be receiving a low amount. However, when it comes to tax, it also means that you will be taxed low for a depreciated property or asset. 

With cost segregation, you can depreciate assets even if they haven’t really decreased in value. 

In a cost segregation analysis, assets are divided into two categories: real property and personal property. The former is the permanent things like the building or foundation of the building. The latter refers to the opposite, things that can be removed from the real property. This could be cabinets or air conditioning units and the like. 

Depreciation years

Generally, real property will depreciate over 27.5 years. Personal properties depreciate in fewer years, between five and 15 years. When you do cost segregation analysis, you are basically adding more years to the depreciation. This way, the amount to be taxed will be lower. 

The money you saved from cost segregation will allow you to be able to invest into worthwhile things. 

Now, let’s talk about what happens when a person sells a property for more than the value that they were taxed on? What they can do is to have a depreciation recapture. This is the process of reporting the gains that should be taxed through a capital gains rate. 

Another way to equalize this is through the 1031 exchange, or the trade of one income property for another or more just to have the same value on both sides. 

However, this kind of deduction may only be available to people that the Internal Revenue Service recognizes as real estate professionals. 

Not to worry, though, as you can always get in touch with real estate professionals for this. Don’t forget to get in touch with a CPA, too. They are the ones who are experts in cost segregation study. It is only when you do things right that you can actually save substantial amount of money. 

It really helps to be informed. Even if you don’t know how to do cost segregation study, the fact that you know it exists, it will already help you out. Even if you have to hire a CPA and real estate professional to complete the process. Ignorance will not save you a cent!

The COVID-19 pandemic has really become a thorn in business. Businesses from all over the world were ordered closed at the peak of the pandemic in order to curtail the spread of the virus. Some of those businesses were forced to permanently close because it was just hard to recover from it. The businesses that survived would have to adapt to the new normal.

Some businesses would need to renovate their establishments in order to cater to the new normal. In the case of restaurants, for example, people are encouraged to eat outside because of the findings that there is a higher risk of virus spread indoors. For most businesses, additional equipment may be purchased to boost online business method.

Cost segregation will really help out businesses save more money.

How does this work?

Properties will depreciate. However, a lot of the properties have a depreciation term of around 39 years. That means that your taxable items wouldn’t decrease until 39 years later. That’s what cost segregation is about. It will allow you to allocate costs at a lower depreciable life.

A property owner could depreciate some properties to just five years or seven or 15. The standard is from 27.5 to 39 years. Even reducing the depreciable life from 39 years to 27.5 could already reduce much of a person’s taxable income.

The process is called cost segregation study. In a business establishment, for example, there are various assets inside the building that can be greatly depreciated by years.

Here’s the best news for business owners: assets purchased from September 28, 2017 to December 31, 2022 have better standing in terms of property depreciation. In the mentioned five years, assets could be depreciated during the first year of ownership. Experts calculate tax savings to be between 33% and 66%.

Misconceptions

There are some issues raised against cost segregation. One common misconception is that it doesn’t work on short-term assets. That’s actually a myth. The property an entrepreneur purchases doesn’t have an intrinsic value yet. It is only when it is used that the market value is added to it. Segregating the assets allows the entrepreneur to determine the values of each by knowing their depreciation lives.

Another misconception is that there is too much trouble doing the cost segregation study and the result is not that significant. That’s a terrible way of looking at it. It is a common process that people work hard to gain something. With cost segregation, it’s not even that hard, especially if you employ the right people to do the job.

The Internal Revenue Service audit technique guide implies that experience and expertise matter when it comes to cost segregation study. There are also various methodologies that can be employed in the study. Choosing the right one will help business owners maximize benefit.

Cost segregation is a proven tax strategy of accelerating depreciation results in order to reduce taxable income. The strategy will allow every business owner to increase their cash flow.