Cost Segregation & Accelerated Depreciation

[Darren Maloney]

Good evening. I am thinking of buying an income property before end of year, in part to take advantage of the generous Jobs Act depreciation allowance which I understand will expire 12/31/22. Does this have relevance to a SFR and 2-4 unit strategy or just more systems-intensive MF, office and industrial assets? Will appreciate any insights. Thank you in advance.

[Ashish Acharya]

Works for any eligible kind of assets. Remember you are not depreciation RE. You are depreciating other assets that come with RE. 

Bonus depreciation doesn't go away, it goes down to 80%. 

[Darren Maloney]

Thank you, Ashish. I don't have an appreciation for the things that come with rental real estate in SFR/2-4 scenario, if any. Could you provide granularity on costs segregated and potential assets? ADU, HVAC, fixtures, appliances? Many thanks.

[Michael Plaks]

Quote from @Darren Maloney:

Good evening. I am thinking of buying an income property before end of year, in part to take advantage of the generous Jobs Act depreciation allowance which I understand will expire 12/31/22. Does this have relevance to a SFR and 2-4 unit strategy or just more systems-intensive MF, office and industrial assets? Will appreciate any insights. Thank you in advance.

I can't endorse buying anything solely (or even primarily) for tax reasons. If you're choosing between such a wide variety of available investments, the most important criteria is choose the type of investment that suits your business goals. Are you after cash flow? After long-term appreciation? Hands-on or hands-off investments? And so on. Starting with depreciation in mind is just wrong, IMHO.

Now, stepping down from my soap box... You're thinking about bonus depreciation. It's available for certain components of any kind of properties. For example, appliances, carpet, driveways/parking, fences, and various other components. Non-residential properties have a few extra options compared to residential properties.

However, before looking at the accelerated depreciation (100% bonus is a form of it), you need to figure out if you will be able to take these losses. It depends on the projected performance of your investment, on your financing, and on your overall financial and tax situation. In other words, it's completely case by case. 

Right now, you're basically trying to select a college for your future child before the child is even conceived.

[Darren Maloney]

Michael, thanks for the reply! I am working with a modest group that will be active in 2023 in MF and commercial income properties.  This commercial objective will be capital gains but with longer hold periods, with income secondary. I will participate in these deals.  Personally, I may do something before then with a similar capital gains objective but with a longer hold and only in a few very narrow geographies.  I will not make an affirmative determination on an investment based on taxes but wanted to be make sure I take they into account should I find anything compelling.  I will be hands on and am seeking an active qualification to capture the offset to other W2 and SE income.  With you, and not leading with taxes!

[Julio Gonzalez]

@Darren Maloney If you are obtaining REP status, cost segregation and bonus depreciation could be a great tax savings benefit to you. As Ashish mentioned, the bonus depreciation doesn't go away at the end of the year, it's just reduced from 100% to 80%. To answer your question on potential assets that are applicable for bonus depreciation, here are a couple articles I wrote with examples.

https://www.biggerpockets.com/...

https://www.biggerpockets.com/...

If you have further questions, please feel free to reach out!

[Bonnie Griffin Kaake]

Quote from @Darren Maloney:

Good evening. I am thinking of buying an income property before end of year, in part to take advantage of the generous Jobs Act depreciation allowance which I understand will expire 12/31/22. Does this have relevance to a SFR and 2-4 unit strategy or just more systems-intensive MF, office and industrial assets? Will appreciate any insights. Thank you in advance.

Yes, Darren, it can apply to SFR, STR and small multi-families as well as major developments, manufacturing facilities, office buildings, medical buildings, etc. The bonus depreciation does not "run out" at the end of 2022. It is based on the year of purchase. Therefore, if you purchase a property between 2017 and 2022 you have 100% bonus. In 2023 the bonus drops to 80% . Then the bonus drops 20% year after year after. Each time it was close to running out, it was raised again. Even if there was no Bonus, you still have the ability to accelerate depreciation with cost segregation. You will get the biggest tax bang for your buck if you purchase by the end of 2022, but that should not be your sole criteria for the purchase.

Don't forget, if you have owned a commercial property for a long time and have put a lot of money into it over the years, you may be able to expense many of those "improvements" with the Tangible Property Regulations (TPRs) of 2014. This can be an incredible tax benefit that is being under-utilized because it is complex.  If you need more information, let me know. 

[Henry Clark]

Darren your base question above:

Does this have relevance to a SFR and 2-4 unit strategy or just more systems-intensive MF, office and industrial assets?

As people have noted, it does apply "but":

a.  Are you able to do the cost seg or paying someone else?  Let's use $1,000 just as a base number for a Cost seg study just because we can multiply it easily.  Let's say you total all of the applicable 15 year or sooner life assets up on a $500,000 home and come up with $50,000 of 15 year or sooner property.  Let's use a tax rate of 25% just for kicks.  Then $50,000 x 25%= $12,500 tax offset.

b.  Do you have the correct type of income to use this $12,500 to offset against in the current year, or you do a loss carryforward into future years.

c.  Was the $1,000 or multiples of that, acceptable to develop the $12,500.

d.  Keep in mind, you will still have to pay the taxes at some point, you just moved the depreciation write-off forward.

e.  Since this is for 15 year life property or sooner, do you plan to hold the assets for that long or longer.  If not, you will have Depreciation recapture and higher taxes then.

f.  You mentioned other investors on a deal.  Find out how the investment agreement handles Bonus depreciation and recapture.  If you and I invest together and I sell out.  If you turn around and sell before the 15 years, then you have to pay all of the recapture, not me.  Need to see how this is handled in your investment. Can you sell or allocate this to yourself or other people, the upfront additional write-off per your agreement.

[Angie Cal]

What is a reasonable price for a cost segregation study for a SFR (4 Bed and 3 Bath) and a townhouse (3 Bed and 4 Bath)?

[Darren Maloney]

Quote from @Henry Clark:

Darren your base question above:

Does this have relevance to a SFR and 2-4 unit strategy or just more systems-intensive MF, office and industrial assets?

As people have noted, it does apply "but":

a.  Are you able to do the cost seg or paying someone else?  Let's use $1,000 just as a base number for a Cost seg study just because we can multiply it easily.  Let's say you total all of the applicable 15 year or sooner life assets up on a $500,000 home and come up with $50,000 of 15 year or sooner property.  Let's use a tax rate of 25% just for kicks.  Then $50,000 x 25%= $12,500 tax offset.

b.  Do you have the correct type of income to use this $12,500 to offset against in the current year, or you do a loss carryforward into future years.

c.  Was the $1,000 or multiples of that, acceptable to develop the $12,500.

d.  Keep in mind, you will still have to pay the taxes at some point, you just moved the depreciation write-off forward.

e.  Since this is for 15 year life property or sooner, do you plan to hold the assets for that long or longer.  If not, you will have Depreciation recapture and higher taxes then.

f.  You mentioned other investors on a deal.  Find out how the investment agreement handles Bonus depreciation and recapture.  If you and I invest together and I sell out.  If you turn around and sell before the 15 years, then you have to pay all of the recapture, not me.  Need to see how this is handled in your investment. Can you sell or allocate this to yourself or other people, the upfront additional write-off per your agreement.

Henry, thanks for the reply.  I will take each sub point by letter.
a.  Intent would be to pay for a cost segs for SFR, 2-4 and commercial properties.  I would use larger shops or specialists for commercial properties given multiple members.
b.  I won’t have enough passive income in 2022 so it would carry forward.  I expect to do the hours to qualify as active/professional in 2023.
c.  I agree there needs to be a cost-benefit,
consistent with my original question.  I have heard as much as 30%-50% year 1 depreciation post cost set study for MF.  Is this a ratio you can share for SFR and 2-4?  If 10% per your example, maybe not since doing nothing would get me close to 4%.
d/e.  Depreciation recapture - I understand that taxes will be due.  Near-term taxable income redux is the objective.  Depending on the specific asset and performance, I will have some discretion on timing. 
f.  Great point that we will need to take up pre-formation!

[Michael Plaks]

@Darren Maloney

The more you respond, the more obvious it is to me that you have an insufficient understanding of the concepts involved. You appear to be seduced by the hype surrounding cost segregation. While cost segregation is a powerful strategy in the right situations, not all situations can benefit from it. Your group should consult with an accountant experienced in tax planning for real estate investments and cost segregation. Relying on general ideas is dangerous when it comes to taxes.

Read this older thread to see why this area is far more complicated than you might think: https://www.biggerpockets.com/...

[Darren Maloney]

Michael, read your old post and I am fully aware that total depreciation remains the same. I always engage qualified legal and accounting professionals prior to transacting in new spaces or employing new strategies. Not sure if it was absolutely clear to you but the purpose of my post was to get some foundational knowledge and opinions as I think about the concept in the context of SFR and 2-4 before engaging professionals and analyzing deals. I got what I was looking for.

[Bonnie Griffin Kaake]

Quote from @Angie Cal:
What is a reasonable price for a cost segregation study for a SFR (4 Bed and 3 Bath) and a townhouse (3 Bed and 4 Bath)?

 Hi Angie, your best bet is to get a no-cost pre-analysis/estimate and then decide with your tax professional/CPA how it fits with your specific tax situation. There are so many variables to "what it costs" that even if I gave you a number, it could be high or low depending on the actual properties. Many things influence the cost of a specific study. I am here to help. 

[Zachary Jensen]

Quote from @Gian Pazzia:

For properties that small, you should budget $450 per property and use cost segregation software like the one below from a trusted brand that has been in business almost 25 years. KBKG was the first company ever to launch a self service software for properties this small and it has been through IRS audit numerous times. KBKG also offers FREE audit support and FREE use of their 481(a) depreciation software which produces the attachment schedules that are needed to file the IRS Form 3115. Tax preparers usually charge another $500 to prepare the 3115 calculation schedules per property so that saves you money. No other software on the market provides all of this for just $450.

In addition, KBKG has more Certified Cost Segregation Professionals (CCSP) in the country. You can check that at www.ASCSP.org and make sure you filter to search for the CCSP designation.

https://www.kbkg.com/residential-costsegregator

Great info to share here! I would also ensure you can even qualify for the cost seg by making sure you either qualify for REPS(real estate professional status) or STR loophole (short term rental loophole)

[Bonnie Griffin Kaake]

Quote from @Darren Maloney:

Good evening. I am thinking of buying an income property before end of year, in part to take advantage of the generous Jobs Act depreciation allowance which I understand will expire 12/31/22. Does this have relevance to a SFR and 2-4 unit strategy or just more systems-intensive MF, office and industrial assets? Will appreciate any insights. Thank you in advance.

This post was made a while back but it is worth responding to with updated information. The Bonus Depreciation of 100% went thru 2022 and then dropped 20% per year. There is a bill that has overwhelmingly passed the House and is being held up in the Senate due to the Child Tax Credit. We fully expect it will be passed by the end of May 2024. It will reinstate the 100% Bonus Depreciation for 2023, 2024, and 2025.

Next point, if you want to know how to choose a cost segregation service provider, be sure to ask the right questions. The cost of an audit can be high. Your best bet is to get an engineering-based study done, ask a lot of questions and get the answers in writing.

[Zachary Jensen]

Quote from @Darren Maloney:

Good evening. I am thinking of buying an income property before end of year, in part to take advantage of the generous Jobs Act depreciation allowance which I understand will expire 12/31/22. Does this have relevance to a SFR and 2-4 unit strategy or just more systems-intensive MF, office and industrial assets? Will appreciate any insights. Thank you in advance.

Hey Darren to break it up for you: 

These provisions can certainly benefit multifamily (MF), office, and industrial assets, they also hold relevance for single-family residences (SFR) and small multifamily properties (2-4 units). The key lies in understanding how the depreciation rules apply to different types of properties and the potential tax savings they offer.

For SFR and small multifamily properties, bonus depreciation and increased expensing limits can still provide significant tax advantages(currently 60% for 2024). Bonus depreciation allows for the immediate expensing of a substantial portion of qualifying property placed in service, including improvements to the property, while increased Section 179 expensing limits enable accelerated deductions for certain tangible property used in the rental business.

Hope that helps!