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:
- Qualified improvement property
- Qualified leasehold improvement property
- Qualified retail improvement property
- 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.