One of the many reasons commercial real estate is so lucrative is the ability for investors to pay less in taxes! Strategic real estate investors do this by utilizing cost segregation, which allows investors to deduct more expenses and speed up the rate at which they can claim tax deductions.
This article will give real estate investors insight into what a cost segregation study in real estate means, how it works, and how it can ultimately reduce investor’s income tax liability, making investments more profitable.
What Does a Cost Segregation Study Mean In Real Estate?
Cost segregation in real estate is a tax strategy for real estate investors, whether passive or active, to reduce taxes by utilizing accelerated depreciation.
As buildings age, the IRS allows property owners to deduct an amount each year that is applied before taxes as part of depreciation expense. Cost segregation can allow you to maximize the amount of depreciation expense that is available by speeding up the decline in property value. As an investor, the more you claim in depreciation, the more you can walk away with after taxes.
Cost segregation can allow you to maximize the amount of depreciation expense available by speeding up the decline in property value.
Most multifamily and commercial real estate properties have a depreciation period of 27.5 or 39 years. With a Cost segregation study, interior and exterior components to the property can be identified and segregated as personal property or land improvements which can speed up the depreciation period to 5, 7, or 15-year periods, significantly increasing an investor’s cash flow!
Benefits of a Cost Segregation Study
Commercial real estate owners can receive significant discounts in tax liability due to accelerated depreciation. On top of an immediate decrease in the amount of taxes paid, this also translates to a temporary boost in cash flow to investors.
How a Cost Segregation Study Works
The IRS holds different timelines for how long a building component’s lifetime will be. Cost segregation studies in real estate will reclassify which IRS category a building component falls into. Investors have the opportunity to ‘accelerate’ the lifetime of a building component speeding up your expense amount. As your expenses increase the more you can offset your taxes.
The IRS breaks expenses into these 4 categories in real estate down the following
- Land: the land underneath your property cannot be expensed
- Personal Property: renovations such as flooring, fixtures, etc. furniture, can be expensed over 5 or 7 years
- Exterior Improvements: renovations such as parking lots, fencing, etc can be expensed over 15 years.
- The Building: is expensed over 27.5 or 39 years depending on the type of asset.
Who Can Perform a Cost Segregation Study?
Cost Segregation Studies in Real Estate can be completed by engineers, construction, or tax professionals. In most cases, engineering firms generally complete cost segregation studies, as studies involve a physical inspection of a real estate property as well as the e-classification of various physical aspects of a building.
And in most cases, a Cost Segregation study will take between 45-60 days to complete.
Qualifications for a Cost Segregation Study
Buildings recent enough to have been built or acquired after 1986 can in most cases, qualify for cost segregation.
When Should a Cost Segregation Study be Conducted?
The Tax Cut and Jobs Act of 2017 added several provisions to the IRS code that allow business owners the eligibility to receive 100% bonus depreciation for qualified assets in their first year rather than overtime. It is recommended that cost segregation studies be completed within the first year you purchased the asset for maximum tax benefits.
How Much is a Cost Segregation Study?
Pricing for cost segregation reports is based on many factors, such as the size of the property and building type. It is a flat fee, and fees typically range between $4,000 to $15,000.
The Bottom Line- Is a Cost Segregation Study Worth It?
Cost segregation studies can be very beneficial in reducing real estate investor’s tax liability; however, there is a cost involved with having a study done, and your tax benefit will largely depend on the type of property at hand. If you’re considering utilizing cost segregation to reduce your taxable income, speak with a tax professional to determine whether it’s worthwhile and what tax savings you can expect to receive. If undertaken correctly, it might lead to tens of thousands of dollars in tax savings – but again, not every investment is appropriate for cost segregation. If you are an owner or passive investor in multifamily real estate we strongly recommend you look into performing a cost segregation study on your property!