How cost segregation is beneficial without REPS status

[Julio Gonzalez]

Many investors think that if they don’t qualify for REPS status, they won’t be able to benefit from a cost segregation study. However, there are multiple ways that you can still benefit!

A cost segregation study is a strategic tax planning tool that separates the assets that have a shorter useful life and can be depreciated over 5, 7 and 15 years from the residential rental property or nonresidential real property that are depreciated over 27.5 and 39 years, respectively. By accelerating your depreciation schedules, you reduce your taxable income which in turn increases your operating cash flow. This also allows for property owners to more easily write-off assets that get damaged/destroyed as the value of these assets is determined as part of the study. You will receive a report as a result of the cost segregation study that supports the breakout between asset classes and new depreciation schedule in the event that you are audited by the IRS. Here’s an example of bonus depreciation.

One way that you can still benefit from a cost segregation study is by utilizing the Short-Term-Rental (STR) strategy on your property. With this strategy, you don't need to qualify as REPS status to be able to take your real-estate losses. You can qualify for this by:

1. Having tenants for 7 days or less at a time.
2. Materially participate, typically with the test: You participated in the activity for more than 100 hours during the tax year, and you participated at least as much as any other individual (including individuals who didn’t own any interest in the activity) for the year.

If you materially participate, you can offset your non-passive income even if you have W-2 income. Here’s a video describing the short-term rental loophole. And here is a video that helps understand how to get the 100 hours for material participation.

Another way is to buy a property in a company name and utilize section 469 grouping activities. “Activities may be grouped if they constitute an appropriate economic unit for measuring gain or loss.” A benefit of this method is that by grouping the activities, it allows you as the taxpayer to treat the activities as one when applying the 7 tests to determine material participation. Here’s an article that further discusses grouping activities under section 469. Know that once a grouping has been established, it must remain for all future tax years.

A third way is to have your spouse qualify for REPS status. If your spouse doesn’t have a W-2 income and works on the investment properties, it could be a good idea to consider REPS status. There are three main requirements for REPS:

1) 750 hour rule

2) Greater than half of professional time rule

3) Material participation

Here’s a great article that walks through the necessities for your spouse to obtain REPS status.

Do you have questions on the ways to benefit from a cost segregation study without personally obtaining REPS status?