Cost Segregation
The Best-Kept Secret In Real Estate
Cost Segregation: How It Works For Taxes
Cost segregation is a strategic tax planning tool that allows property owners to accelerate depreciation deductions on certain building components and land improvements of a real estate property. It involves identifying and reclassifying certain components of a building's cost into shorter depreciation periods, instead of using conventional tax depreciation methods.
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Conventional tax depreciation methods depreciate the cost basis of residential real estate over 27.5 years and commercial real estate over 39 years. A Cost Segregation Analysis identifies and reclassifies the cost of certain building components into 5- and 15-year recovery periods, instead of using the conventional 27.5- or 39-years on the entire cost of the property.
By reclassifying costs into shorter recover periods, investors are able to accelerate depreciation on the qualifying building components early on, resulting in increased tax benefits over the first few years. This analysis is a 20+ page report given to your CPA or Accountant during the preparation of your taxes. The results of the Cost Segregation are implemented on your tax return.
What Properties Qualify?
Any real estate property used for business or rental. This includes long-term rentals, vacation rentals, Airbnb properties, farms, wedding venues, commercial properties, apartment complexes, multi-family, RV parks, golf courses, medical facilities, restaurants, retail, warehousing, storage buildings and more. Typically, a property needs to cost at least $250,000 or more for the tax benefits to be worth the cost of performing a study.
Valuable Assets To Segregate
Potential 5- Year Building Components
Certain building components that are not permanently attached to the building structure or an integral part of the building structure. Examples include kitchen appliances, kitchen cabinets/millwork, certain types of flooring (carpet, vinyl, LVP), wallpaper and strippable wall coverings, certain crown moldings/millwork, certain specialty plumbing & electrical work, kitchen equipment, decorative millwork, theme-related decor, audio/video equipment, shelving/display racks, furniture, and more.
Potential 15- Year Land Improvements
Land Improvements include driveways, parking areas, sidewalks/patios, exterior fencing/gates, landscaping/trees/shrubs, mailboxes, swimming pools, docks/bridges, roads/curbs/gutters, site drainage, exterior lighting, certain grading/sitework, light poles, & more.
Standard 27.5- and 39- Year Property
Assets that aren't separated into shorter recovery periods include the buildings foundation, structure, electrical system, plumbing system, interior lighting, painting, insulation, doors, windows, bathrooms, utility hookups, AC system, plumbing/light fixtures, and any other assets that are considered permanently attached to the building structure or considered an integral part of the building's purpose.
An Example In Action
We had a client purchase a vacation home in Texas for $415,000 in 2023. Another $144,000 was spent on Improvements. Total spent was $559,000 and the property was finished in December. The land was valued at $57,000. The Client’s tax rate was around 30%.
Before Cost Segregation
After Cost Segregation
Total Spent: $559,000
Land Value: $57,000
Depreciable Basis: $502,000
Date in Service: 12/1/2023
Useful Life:
5-Years: $0
15-Years: $0
27.5-Years: $502,000
Bonus Depreciation: None
2023 Depreciation: $763
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2023 Tax Savings: $229
Total Spent: $559,000
Land Value: $57,000
Depreciable Basis: $502,000
Date in Service: 12/1/2023
Useful Life:
5-Years: $63,915
15-Years: $93,363
27.5-Years: $344,722
Bonus Depreciation: $125,822
2023 Depreciation: $127,218
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2023 Tax Savings: $38,165