Cost Segregation: A way to Lower your Taxes and Increase Cash Flow
Interested in making the most out of tax time? Keep reading to learn more about Cost Segregation!
Summer is an excellent time to do some tax planning with your CPA. The dust has settled from the filing deadlines, the tax pros have likely come back from their vacations and may have some extra time to talk STRATEGY.
Cost Segregation is a smart tax strategy used by real estate investors to save money by analyzing the costs tied up to a property. Usually, when you buy a commercial property, you must spread out the tax deductions over a long time, commonly within 39 years or 27.5 years if a residential rental property. With cost segregation, you hire engineering and tax experts to help you can break down the property into different parts with shorter tax deduction periods. From 39 years, you can break it down to 5, 7 or, 15 years! This lets you claim more deductions early on, which can result in substantial tax savings. Depending on when the property is put in service, you can take advantage of bonus depreciation where even more tax benefits can be leveraged!
So, what are the Benefits of Cost Segregation, anyway?
Efficiency in operations: More than the Tax-Savings, a Cost Segregation Study will give you a glimpse of how each component of your property is doing and if it needs extra care. This will save you operating costs over time, by efficiently managing and maintaining your property.
Tax liability reduction: By segmenting your property into different parts, you can now accelerate your depreciation which can offset some types of income with benefits that may be able to be carried forward in future years.
Increase in your Cash Flow: Well, this one is simple. The less tax you pay, the more money you keep for yourself!
It doesn’t end there…
Individuals qualified as a "Real Estate Professional" based on the IRS Rules, can potentially deduct all their real estate losses against their active income, without being subject to the passive activity loss limitations. (Are my fellow Real Estate agents listening?!)
For married individuals who file their taxes together, and have one qualifying “Real Estate Professional,” there's an extra benefit! The real estate losses from cost segregation can be used to reduce the combined income from both of you. So, if your rental income losses are more than you’re the profit you earn from the property, that loss margin can potentially lower the taxable income from your spouse's job- even if the spouse has income from a W-2 job!
How long does it take to complete a Cost Segregation Study?
Since each study is unique and is based on numerous factors, a Cost Segregation Study could be completed within 30 - 60 Days in general. Tax Professionals and Engineers may take each of these into account when doing the study for your property:
The Specifications of your Property: Size, Type/Category, Components; Your hired professionals consider the information you’ll provide crucial to fully provide you with an effective Cost Segregation Study at a reasonable time frame.
Documentation: The time frame of the study all boils down to how accurate and well-organized your records are. The more documents you provide your hired professionals, in an organized fashion, the faster they may finish your study.
What’s the catch?
Like all things, there are caveats and things to watch out for - these engineering studies will not make sense to do for many people. If you are interested in learning more to determine if you could benefit, here are a few tips to help you determine the next steps:
Make sure your CPA has experience with cost segregation studies. Ask them what firms they recommend to complete the study and to help you understand if it would reduce your tax liability. To confirm their level of expertise, here is a test: Ask them if short-term rentals are classified as residential or commercial property. A seasoned real estate CPA with expertise in depreciation strategies will know they are currently considered commercial, according to IRS Rules.
If you plan to sell a property in the near future, the strategy may not be a fit. It would be best to have your CPA model the outcomes for your unique situation.
Understand what rules and benefits you are looking to qualify for and have your tax professional confirm you pass the qualification tests.
The cost segregation studies are not inexpensive. Your tax professionals should be able to help you to determine if the ROI is worthwhile.
This is just an introduction to this amazing and more advanced approach to taxes. This is in no way intended to be financial or legal advice. Like any strategy, the implications of cost segregation studies will be unique for each taxpayer’s situation and results will vary. It's best to talk to a real estate tax professional and a cost segregation company to help with tax planning in determining the best real estate tax strategy for your situation and investing goals.
