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Cost Segregation

Cost Segregation Study: Myths & Truths

Cost segregation study has become a very important strategy to reduce taxes among real estate investors. When done right, an investor could save hundreds of thousands of dollars in taxes. That’s the thing, it has to be done right.

Cost segregation is the acceleration of the depreciation of assets. The definition alone could really hurt one’s brain, especially if they are not experts on the matter. The confusion over the complexity of cost segregation study has led to some misconceptions.

Check out some of the myths about cost segregation:

Multifamily housing property depreciates over 39 years

Actually, it’s the non-residential properties that get depreciated over 39 years. For residential buildings, as in the case of multifamily housing properties or apartment complexes or condominiums, the depreciation is only over 27.5 years.

That’s more than a decade difference that could really affect the cost segregation study. Residential properties are depreciated using the straight-line method along with the mid-month convention.

But what constitutes a residential rental property? This is an important question since there are a lot of buildings that have both the residential and commercial sectors. To be considered as residential rental property, at least 80% of the gross income should come from residential rents.

Apartment complex improvements are covered under the QIP

Qualified improvement property or QIP refers to non-residential buildings. There are four categories under the QIP:

  1. Qualified improvement property
  2. Qualified leasehold improvement property
  3. Qualified retail improvement property
  4. Qualified restaurant improvement property

What is the importance of knowing these categories? This is because the Tax Cut and Jobs Act of 2017 amended the previous provision that expensing would include tangible personal property. The amendment clarifies what are covered in the QIP.

Specifically, those covered include the roofing, heating, air conditioning and ventilation, alarm and security systems. However, adding extension to the building is not covered. Other improvements that are not considered in the QIP are elevator and escalator, internal framework of the building as well as the exterior.

39-year depreciation is always terrible

This is not necessarily true. It could be true, but it’s not always true. This is particularly note-worthy among owners of mixed-use buildings. Here’s the deal: When the building’s commercial establishments are less than 20% of the occupancy, there is no effect on revenue test. This is because the revenue test looks at the revenue, as the name implies, and not on occupancy.

This way, when QIP is imposed, it would be to the owner’s advantage especially when there have been improvements or when there is a plan to make some improvements. This could push the owner to benefit from the 100% bonus depreciation covered under the QIP.

Owners, though, would have to identify structures or certain structural parts of the construction projects that would have to maintain the 39-year depreciation.

For the untrained eye, everything mentioned would seem very complex indeed. One could greatly benefit from getting a specialist to study the properties and assets in order to maximize the benefits of the cost segregation study and not fall for the common myths.

How Real Estate Investors Can Increase Cash Flow by Reducing Taxes

With coronavirus still raging on, the economy is yet to stabilize. Thousands of people lost their jobs and most businesses have really been in trouble. Real estate is not doing good either. With people’s livelihoods in trouble, buying or investing in real estate is the last thing on their mind right now.

This is why it is essential for real estate investors to be really practical with their money. They have to be frugal and smart. One way to really make a dent in the cash flow is to reduce taxes. Real estate investors who may not have been meticulous with their taxes before should now be looking for ways to benefit from the tax rules.

A good way to reduce taxes is by maximizing the benefits of depreciation. Every asset has a useful life, which is the estimated number of years by which this will serve its purpose for the business. In essence, every year, the useful life decreases. That’s when depreciation comes in and lowers a taxpayer’s taxable income.

Cost segregation

The process by which a taxpayer imposes the depreciation of assets is called cost segregation study. This strategy accelerates the depreciation of assets n order to lower taxable income.

To be more specific about it, a multi-family property, for example, has a depreciation schedule of 27.5 years. With cost segregation study, a taxpayer can separate the property’s assets to have a much faster depreciation. The assets, minus the lot, could have depreciations of five, seven and 13 years. In some cases, the tax benefit could be over a million dollars.

However, cost segregation study should be done right for real property investors to really reap the benefits. The best way is to hire an expert like a cost segregation specialist. An expert could really take a look at one’s property and assess every asset that could aid the reduction of tax. While hiring a specialist will cost money, the savings that will result from it is so much more.

Bonus depreciation

Couple the cost segregation study with bonus segregation and it could really turn one’s financial woes around. The Tax Cuts and Jobs Act of 2017 includes a provision on bonus deprecation. It has always been available but only for new developments. The law allows the same strategy for new purchases.

But what exactly is this? It is a provision that allows real estate investors to get 50% to 100% depreciation during the first year as long as the asset has a useful life of less than 20 years. Although, this strategy can only be used for real properties used for business and not for personal properties.

It really pays that people understand how taxes work and the strategies that will allow them to save money by reducing tax. For those people who are still confused, there are experts that can help them with both cost segregation study and bonus depreciation. Basically, if one is reducing their taxes, then they are essentially increasing cash flow.

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