If you are a real estate investor, chances are good that you want to take advantage of every tax benefit you qualify for. With that in mind, today we take a closer look at cost segregation, an IRS-approved tax strategy designed to help you increase your cash flow.
What Is Cost Segregation in Real Estate?
As the name suggests, cost segregation is a tax strategy that consists in separating or setting apart the costs of the components of a property in order to accelerate depreciation deductions.
Cost segregation is helpful from a tax perspective because while a commercial property as a whole depreciates over 39 years, some of its components (such as fixtures, wall coverings, or carpeting, just to name a few) are depreciated over five, seven, or 15 years.
This means that since some portions of the property depreciate at an accelerated rate compared to others, cost segregation dramatically increases the tax deductions you can claim.
For example, if you purchase a commercial building for $2,500,000 and don’t use cost segregation, the cost (and the tax benefits you can enjoy) would look as follows:
- Building: $2,000,000 (depreciates over 39 years, or about 51,000 per year )
- Land: $500,000 (doesn’t depreciate)
Now, after using cost segregation, the numbers may look like this:
- Building: $1,500,000 (depreciates over 39 years)
- Personal property: $400,000 (depreciates over five or seven years)
- Land improvements: $100,000 (depreciates over 15 years)
- Land: $500,000 (doesn’t depreciate)
How To Take Advantage of Cost Segregation?
If you are interested in taking advantage of cost segregation, the first step is to contact a professional who can perform a cost segregation study.
Simply put, a cost segregation study is the process of identifying the different components of a real estate property and reclassifying them as either “personal property” or “land improvements” under the federal tax code.
When you commission a cost segregation study, it’s important to work with a professional who’s up to date
It’s worth keeping in mind that even if you use cost segregation, the building itself will still depreciate over 39 years (or 27.5 years in the case of personal property). Also, remember that land DOESN’T depreciate.
Disclaimer: This material is for general information and educational purposes only. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions.
SoCal CRE Team: Commercial Real Estate in Southern California
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