Understanding Depreciation and Cost Segregation

Real estate is often chosen by investors for its tax benefits. United States tax law provides certain tax strategies that shelters taxable income, reducing tax liability. This is done through cost segregation that separates components of a property into different depreciation categories, allowing some to be realized at an accelerated rate.

Taking a deduction to recognize the decrease in value of an asset over time caused by its use, wear, and tear. Most real estate uses straight-line depreciation, which takes the entire value of the asset and reduces it evenly over a certain period of time. This time period is 27.5 years for residential property and 39 years for commercial property. Multifamily complexes jump between being classified as commercial or residential, depending on the business process taking place. When looking to purchase or sell a multifamily property over 4 units, then the property is considered part of commercial real estate. For depreciation purposes, the tax code labels multifamily properties as residential, so a 27.5 year depreciation timeline would be used if the straight-line method was chosen for tax purposes.

However, depreciation can be accelerated or bonus depreciation used when cost segregation is applied.

A cost segregation study or segregation analysis can be completed on a property to separate the elements of the property into different groups that more closely represents the true lifespan of the element. These groups shorten some of the interior and exterior components of the property into 5, 7 or 15 year depreciation times, rather than the full 27.5 years. This enables the property owner to write off some of the depreciation at an accelerated rate, which reduces taxable income while increasing the business’s cash flow and profitability.

A cost segregation study that produces a formal analysis report should be completed by a professional with experience in engineering, architecture, construction, and tax accounting. Every item that is connected to the property or part of its structure will be separated into the 5, 7, 15 or 27.5 year recovery period, this is the number of years over which the depreciation cost can be spread.

These studies can cost thousands of dollars to complete. Generally, only commercial real estate investors and rental property owners with many properties, who can benefit from a reduction in their significant taxable income, will have studies done. Most companies that perform the cost segregation studies offer a quick analysis to determine if the tax savings will be significant enough to pursue a full study. For the maximum tax benefits, it is best to have a cost segregation study done within the first year following the purchase, remodel or construction of a large property.

Several new tax code sections, including 179, were added with the Tax Cuts and Jobs Act of 2017 that went into effect in 2018. The largest change made is that businesses can take 100% bonus depreciation in the first year on qualified assets instead of spreading the depreciation over several years. This 100% bonus depreciation is available on properties purchased between January 1, 2018 and January 1, 2023. After that, the bonus depreciation begins to phase out until it is completely gone in 2027.

Depending on the property, a cost segregation study and utilizing bonus depreciation can generate tens of thousands or even hundreds of thousands in tax savings. Large multifamily complexes are the ideal property type to perform cost segregation studies on. Wave Impact Capital Group utilizes this benefit by allowing all who invest in our properties to enjoy the paper losses while money flows into their pocket.

Depending on the property, a cost segregation study and utilizing bonus depreciation can generate tens of thousands or even hundreds of thousands in tax savings. Large multifamily complexes are the ideal property type to perform cost segregation studies on. Wave Impact Capital Group utilizes this benefit by allowing all who invest in our properties to enjoy the paper losses while money flows into their pocket.