As a rental property owner or real estate investor, it’s vital to crunch every number and maximize every advantage to stay in the black, and that includes employing tax strategies available to you.
Chief among those is a cost segregation study, which allows us to analyze commercial or residential real estate and identify individual components that can be reclassified as personal property or land improvements instead of real property. By doing so, we can shorten the schedule of depreciation for certain elements of your property, reducing your income tax obligation.
So, how does it work? By conducting a cost segregation study, we’re able to differentiate certain costs from these categories:
1. Personal property
2. Land improvements
3. Buildings or structures
Why is it important to reclassify certain elements as personal property or land improvements through a cost segregation study?
With personal property and land improvements, the IRS allows you to accelerate or shorten the depreciation timeline, which allows you to generate additional depreciation deductions, sheltering more of your hard-earned money and paying less in income taxes today. I say, a dollar today is worth more now than a dollar in 27.5 or 39 years!
For instance, personal property such as fixtures, furniture, window treatments, carpeting, etc. may be assigned a 5- or 7-year depreciable life.
Additionally, land improvements that we identify and segregate can be reduced to a 15-year depreciable life, including paving, landscaping, and even costs for sidewalk installation or maintenance.
But your actual building or structure can only be depreciated over 27.5 years (for residential real estate) or 39 years (for commercial or non-residential real estate.)
Let’s not forget about bonus depreciation. Since the Trump’s Tax Cuts and Jobs Act, we now have a temporary 100 percent bonus depreciation for qualified property acquired and placed in service after Sept. 27, 2017, and before Jan. 1, 2023. This means that personal property and land improvements can be expensed in the year that you purchased it or placed it in service.
We can basically segregate and reclassify depreciation for any tangible personal property, such as any equipment, furnishings, cabinetry, and floor coverings. However,
components like heat & air (HVAC) units, plumbing, framing, wiring, and some forms of lighting fixtures are considered part of the building and are subject to depreciation over 27.5 years or 39 years.
(In case you were wondering, land cannot be depreciated.)
To enjoy significant income tax savings and free up cash flow, a cost segregation analysis provides everything you need for accelerating your property’s depreciation according to the new rules.
Who can qualify? Typically, anyone who has built, acquired, or improved commercial or residential real estate is eligible for a cost segregation study and its taxation benefits.
Let’s look at a real-life example of a cost segregation study below: