The Beauty of Cost Segregation

Its uniqueness comes from the fact that you don’t have to pay for all of the building. The bank will pay for 80% of it. Your tenants pays to the bank with their rent. Even the bank pays for most of the building, you get 100% of the depreciation deduction.

The IRS understands that land improvements and the content of the building depreciate faster than the building itself. Remember, you get $0 for depreciating land simply because land never depreciates by itself.

On an average here’s how the depreciation rates look for the following real estate investments:

  • Building: – anything between 2.5-3.6%
  • For contents: – 15-20%
  • Land Improvements: – 5-10%

For commercial buildings, 50-60% of the cost consists of contents and improvements and therefore a lot of depreciation can be created in the initial years of ownership.

Some CPAs will call it aggressive and might talk of recapture tax. They are less informed and lazy by all standards!

With good tax planning, you can avoid paying the recapture tax at the time of disposing of the property.

Do them on all of your properties, depending on the value of the property itself.

There are some rules though that need to be followed while doing a cost seg study. Make sure you work with a CPA who knows the ins and outs of the strategy.

In a cost seg study, you are deducting depreciation from each of the components that relate to the operation and maintenance of the building.

Examples: ceilings, roofs, HVAC units. bathroom fixtures such as tubs and sinks, stairs, floors, landscaping, pavements can be depreciated using a cost seg.

Q: What happens if I do not get a cost seg done on my property/ies?

Well, in the absence of component depreciation or a cost segregation (same thing), your property would be subject to the straight-line depreciation where the:hh

Rate of depreciation= Cost of Building/ Number of years it takes to depreciate a property

Which is,

27.5 years for residential structures

39 years for commercial structures as given by the IRS

You can take both the standard, normal depreciation (just explained above with the formula and everything) and the component depreciation (which is nothing but a cost segregation study) both in the same year.

Under the Tax Cuts And Jobs Act of 2017, another great depreciation was introduced which is known as the 100% Bonus Depreciation. Under the third type of depreciation, you can write off land improvements and personal property completely, a 100% (no typing mistake here, btw!) in the 1st year itself.

Bottom line: You have multiple types of depreciation that you can use to write off your assets. You need to figure out which one or two of them works best for you!

We specialize in tax planning for real estate investors and small businesses.

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