The following article was by our 2018 Summer Intern, Sam Witner (University of North Carolina at Chapel Hill, class of 2021), under the supervision of partner Nick Gonzalez.
While another tax season has come and gone, some may still have residual shock of writing a check to Uncle Sam. Fortunately, for real estate investors, there is a way to substantially reduce your tax liability, and it’s all within the IRS tax code.
Seeking Tax Benefits
Most real estate investors are familiar with the benefits, and oftentimes necessity, of using depreciation as a way to lower your tax burden (or at least your CPA is). By decreasing taxable income, your cash flow increases, which gives you more freedom to reinvest, pay down principal, or make improvements and repairs to your property. Taking advantage of depreciation and its benefits is one of the main reasons many of our clients look to real estate as a tax-friendly, long-term wealth-building investment option.
A cost segregation study is a way of further decreasing your tax burden. It gives you the ability to increase the amount of depreciation on a property, which, although not appropriate for all investments or situations, can dramatically increase the way your investment grows.
“Taking advantage of depreciation and its benefits is one of the main reasons many of our clients look to real estate as a tax-friendly, long-term wealth-building investment option.”
What is a COST SEGREGATION Study?
A cost segregation study is an engineering-based analysis that separates the costs of each component of a property. This includes separating the land, land improvements, buildings, equipment, and fixtures. In performing this type of analysis, much more property is reallocated as tangible personal property. While a commercial property can be depreciated over 39 years, personal property is depreciated over 5 to 7 years. This shorter depreciation timeline results in a larger tax deduction each year, freeing up more cash flow. A third-party firm can prepare the cost segregation study for you, and oftentimes your CPA can forecast what implications that study may have on your depreciation schedule to allow you to assess the cost/benefit.
Pros and Cons Of Cost Segregation
- Decreased tax burden
- Increased cash flow
- Availability to use freed-up cash to invest
- Shorter depreciation recovery periods will result in an increased tax bill down the road.
- Depreciation recapture can hurt when it comes time to sell (Unless you do a 1031 Tax-Deferred Exchange)
A knowledgeable broker and experienced CPA are great resources to help you navigate cost segregation studies. Taking advantage of this and other tax strategies are key to building a well-rounded real estate investment portfolio.