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Introduction to Cost Segregation
If you own income-producing real estate and would like to lower your income tax bill, cost segregation might be the answer. Cost segregation for 2023 and earlier years can still be done. Your tax return can be amended, or, if not filed, can be filed to include cost segregation, thus lowering your tax bill, or generating a refund.
This is Dave Horwadell, CEO of Torchlight Tax and GuardDog Tax. Cost segregation is a tax-savings strategy that can be started after the tax year is over. A Cost segregation study identifies the different components that comprise a property, exclusive of land, and divides them into different categories based on their useful life as defined by the IRS. Normally, a building structure depreciates over 27 and a half years (residential) or 39 years (commercial) using a straight line schedule. This is easy and generally used by taxpayers and tax preparers. But when you buy real estate, there are many things included with the building that could be depreciated faster than the building structure, such as parking lots, landscaping, appliances, flooring, cabinets, and even some electrical and plumbing. These depreciate in five, seven, or fifteen years. Splitting these items off is called cost segregation and allows your depreciation to be accelerated. In the 2018 Tax Cuts and Jobs Act, this bonus depreciation allows you to take 100% of the depreciation for 5, 7 and 15 year rental real estate components for tax years 2018 through 2022. You can take 100% depreciation for these 5, 7 and 15 year components all in the first year. This bonus depreciation started to phase out in 2023. For 2023, 80% of the depreciation for all 5, 7 and 15 year components can be taken. It is possible this will go back to 100% for 2023 based on proposed legislation approved by the House and now in the Senate. Also, real estate professionals, those who are materially involved in real estate, and Airbnb owners can use accelerated depreciation to offset their regular active income. (Otherwise, it can be used to offset passive income.) Example: Let us assume you are Married Filing Jointly with no dependents, and you or your spouse qualify to offset your regular active income. You bought a newly built or used property in 2023 for $1.5 million. Suppose you got a good deal on financing and put only 50k down, a little over 3%, and your active income was $650,000. A cost segregation study shows you have $375,000 depreciation total in 5, 7 and 15 year components of the property. If you qualify as a real estate professional, or the property is an Airbnb for 2023, you can take 80% of $375,000 as bonus depreciation–$300,000. Please note: It is sometimes possible to arrange to qualify to offset your regular income. For example, a non-working spouse can take over the management of your real estate, or you can put your property in service as an Airbnb. This $300K comes off your 650K of regular income and would reduce your tax bill from 184K to 104k. An $80,000 savings!! What if you had two or three such properties? You could zero out your 2024 income taxes and carry forward the loss into the next year. Note that your tax savings exceeded your down payment in this example. Cost segregation accelerates your depreciation, deductions and defers federal and state income taxes. Faster depreciation creates more cash upfront to invest back into your business. A secondary benefit to cost segregation is to maximize future write-offs when building components like windows or HVAC units are replaced down the road. The cost segregation report provides the cost detail and allows you to take these further write-offs. Do you qualify for cost segregation? Anyone who has constructed, purchased, expanded, or remodeled any kind of real estate in the last 20 years is a candidate for cost segregation. This only applies to income-producing real estate. If you have a personal home you would like to turn into a rental property, there are some amazing tax breaks which most homeowners miss. (If this is the case, you could set up an S corporation that you would use to buy the property from yourself to save SUBSTANTIAL taxes in many cases.) Contact Torchlight Tax today for a free consultation and estimate of your tax benefits. Torchlight Tax is a full-service tax firm that can handle all your tax and accounting needs, including cost segregation. We also do IRS audit defense, IRS debt negotiation, tax planning, asset protection, and set up entities such as LLCs, corporations, and trusts for asset protection and tax saving purposes. Having the capability to deliver all these services allows us to maximize the benefits our clients receive through these related activities.
Contact Torchlight Tax at 1-877-758-7797 or email us at info at TorchlightTax.com.