Why You Need To Consider a Cost Segregation Study Now
February 28, 2023
Cost segregation has been a tool savvy real estate investors use to allow subcomponents of a building to be deprecated in an accelerated timeframe, reducing tax liability and freeing up cash flow. Additionally, in 2023 there is an added benefit of 80% bonus depreciation to minimize tax liability further.
The Benefit of a Cost Segregation Study
Cost Segregation is a study conducted on an industrial real estate or residential rental property to determine if specific components qualify for accelerated depreciation. Traditionally, a non-residential or industrial real estate property would have its depreciation spread out over 39 years, and a residential rental property would spread out its depreciation over 27.5 years. In both those cases, the yearly depreciation is on the entire building. The benefit of a cost segregation study is that specific components may qualify for accelerated depreciation: An example of some of the considerations is:
- Plumbing
- Flooring
- Electrical Systems
- Ventilation Systems
- Parking lots
- Landscaping
- Security and Fire protection systems
Additional components included in the cost segregation study are not named here. These components fall into tax categories that can be depreciated much quicker than the entire building structure. The depreciation is an asset-based depreciation that lowers the investor's annual taxable income.
When Should A Cost Segregation Study Be Conducted?
The IRS has recommended that all investment property that changes ownership undergo a cost segregation study. This would ensure that each owner's tax situation is reviewed and considered even if the investment property purchased was part of a previous cost segregation study.
Working with your CPA, you can have a cost segregation study conducted as a stand-alone or as part of a 1031 exchange. Combining a 1031 exchange with a cost segregation study may allow the real estate investor to defer capital gains taxes and reduce operating expenses.
Bonus Depreciation Timing
Another tax benefit for real estate investors in 2023 is bonus depreciation. Bonus depreciation allows businesses to deduct a large percentage of the costs of business assets the year they are purchased. The Tax Cut and Jobs Act (2017) raised the bonus depreciation rate to 100% to encourage investment and stimulate the economy. Under current tax law, bonus depreciation decreases 20 points each year over the next few years until it sunsets in 2027.
- 2023 = 80%
- 2024 = 60%
- 2025 = 40%
- 2026 = 20%
- 2027 = 0%
With the yearly reductions in bonus depreciation, now is the time to work with your CPA, review any planned improvements to your real estate investment, and ensure you receive the full benefit of cost segregation with bonus depreciation.
Most investors purchase buildings intending to hold them for part of the 39 years for industrial or 27.5 for residential real estate. Taking advantage of these tax incentives, real estate investors have continued to build their portfolios with the capital freed up, allowing them to reinvest in additional properties.
Considering Cost Segregation?
Contact our team to review and discuss your unique situation and how you can take advantage of cost segregation, bonus depreciation, and/or 1031 exchange tax credits to enhance your real estate investment portfolio.