Cost Segregation and Bonus Depreciation on Taxes

Realtor · Provo, UT · Member since 2016 · 119 posts · 73 votes

I recently attended a class on advanced tax strategies for real estate investors. As we all know the standard "straight line" depreciation allowance from the IRS is a 27 year depreciation schedule on residential investment properties and I believe that it is 39 years for commercial property. This is a great tax benefit to real estate investing in and of itself. What most investors and even their CPAs don't seem to know is that a large portion (25-40%) of the cost of these investments can be classified as 5, 7 or 15 year depreciation property. This allows the investor to take a much bigger ded

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Jake HottenrottPro Member

CPA · Belleville, IL · Member since 2014 · 255 posts · 269 votes

@Sam Levin you are correct in stating that cost segregation studies can be very beneficial to to the knowledgeable investor. The trick is that your technique and logic must be very well documented and must be done in a manner approved by the IRS. Providing information to other investors can be very valuable, but be careful about the manner in doing so. The tax and penalty ramifications of having a cost segregation done improperly and disallowed partially or in whole by the IRS can be significant.

@Natalie Kolodij hits the nail on the head that many of the CPAs and EAs on these message boards use these type of studies regularly to help clients where applicable. If you meet with a REI focused CPA, this is the type of value that can be provided to you. A general tax CPA may not encounter this regularly. Many of us have contacts that do nothing but cost segregation studies nation wide and would be happy to provide those contacts to you on request.

Also, not to be nit picky, but I'm a CPA so attention to detail is a must. The depreciation life of a residential real estate asset is 27.5 years.

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Sam Levin
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Realtor · Provo, UT · Member since 2016 · 119 posts · 73 votes
9y
... as I was saying, this allows the investor to take a much bigger deduction on taxes over the first 5 years.
On top of that investors who build their own or buy brand new buildings get a "bonus depreciation" of 50%(!) from the IRS as well. As a real world example: I am closing on a brand new fourplex right now in Provo which is in Utah County. Using the straight line depreciation method I was expecting to get a $9k depreciation on taxes for 2016. Now that I am using the advanced techniques I can claim $90k in depreciation this year!!!
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Natalie KolodijBusiness Member
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Tax Strategist| National Tax Educator| Accepting New Clients · Member since 2014 · 3k+ posts · 4k+ votes
9y
I wouldn't suggest soliciting to offer people information on a complex tax matter on here unless you're actually qualified.
If you're not a CPA or an EA you likely shouldn't be "teaching" techniques you learned in a weekend class. Many CPA's do know about this, and do apply it where applicable.
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Jake HottenrottPro Member
CPA · Belleville, IL · Member since 2014 · 255 posts · 269 votes
9y
@Sam Levin you are correct in stating that cost segregation studies can be very beneficial to to the knowledgeable investor. The trick is that your technique and logic must be very well documented and must be done in a manner approved by the IRS. Providing information to other investors can be very valuable, but be careful about the manner in doing so. The tax and penalty ramifications of having a cost segregation done improperly and disallowed partially or in whole by the IRS can be significant.
@Natalie Kolodij hits the nail on the head that many of the CPAs and EAs on these message boards use these type of studies regularly to help clients where applicable. If you meet with a REI focused CPA, this is the type of value that can be provided to you. A general tax CPA may not encounter this regularly. Many of us have contacts that do nothing but cost segregation studies nation wide and would be happy to provide those contacts to you on request.
Also, not to be nit picky, but I'm a CPA so attention to detail is a must. The depreciation life of a residential real estate asset is 27.5 years.
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Rebecca Belnap
Rental Property Investor · Lehi, UT · Member since 2015 · 195 posts · 133 votes
9y
I recently went to a continuing education class that was likely presented by the same people
@Sam Levin saw. He is in no way saying that you can do it without a trained tax professional. It is more of a way to let people know that there are better ways to claim your depreciation earlier when you need it most.
Even after the class, I have no idea if the carpet is a 5 year or a 7 year asset, but I do know that if done properly (not by me) I can fully depreciate it in a lot less than 27.5 years, and if my tenant trashes it, I can expense the remaining value of the carpet, replace it and start depreciating the new carpet. This is true of light fixtures, countertops, cabinets, and the bushes in the landscaping, but only if you have a full inventory of all the assets in the property. It isn't to tell us how to do it, but to know what a trained professional can do to help us be more profitable. It's very hard to cash flow a property in the early years and this helps if you are in the higher tax bracket.
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Sam Levin
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Realtor · Provo, UT · Member since 2016 · 119 posts · 73 votes
9y
Thanks very much Jake Hottenrott, you sound like an extremely knowledgeable and tactful professional accountant. I agree that proper documentation is a must for something like this. I would of course refer any of my clients' or other parties' inquiries on this matter to a professional cost segregation specialist. I have done so for several of my investor clients already and it is literally going to collectively save them hundreds of thousands of dollars on their 2016 taxes. As you can imagine they are quite pleased.
Hello Natalie Kolodij. I see you have chosen to "not suggest" that I offer other people useful tax information here and that you have even gone on to imply that I am somehow not qualified to share investment related tax information on an investor's forum site. With all due respect I thought that was the whole idea behind the Bigger Pockets forums.
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Natalie KolodijBusiness Member
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Tax Strategist| National Tax Educator| Accepting New Clients · Member since 2014 · 3k+ posts · 4k+ votes
9y
I would say the point of bigger pockets is to share helpful, useful, information. But if you're not a tax professional you should not offer to advise people on tax matters. Same way tons of people disclose not being a lawyer when giving any advice on here that relates to anything legal in nature. You will note the tactful, professional other CPA also cautioned you on how you present it.
People who are interested in this strategy should be encouraged by your post to discuss it with their CPA. As Rebecca mentioned she too attended this (or a similar) class and it's not suggested to undertake this without a CPA.
I'm glad your clients are pleased with current year savings. I'm sure their tax professional discussed the associated risks regarding AMT, 1245 tax and 1031s.
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Brett Sorenson
Investor · Minneapolis, MN · Member since 2016 · 57 posts · 36 votes
9y
As a CPA I would highly recommend having a five year plan prior to contemplating accelerated depreciation. It will all he recouped upon the sale of the property. It also depends on what tax bracket you fall into whether all of the benefits can be used.
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Aaron Smith
Bountiful, UT · Member since 2016 · 112 posts · 52 votes
9y
@Sam Levin you have to account for recapture as well. Cost segregation is awesome, but it's an expensive study depending the size of the property. I believe Amanda Han covered it a bit in her book.
And if you can do this without a CPA.. you're a smart person :D Your CPA, if they're RE investors themselves, or specialize in accounting for REI's, will know someone who can conduct the study for you.
Thanks for posting about this though, as I think new investors would not think of this.
All the best, and Happy Holidays to everyone here!
Aaron
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Paul Caputo
Cost Segregation Specialist · Naperville, IL · Member since 2016 · 204 posts · 168 votes
9y
You're absolutely right that the tax benefit of cost segregation represents a cash flow windfall for investors holding over 5 years, but it's a lot more complex than applying a few hours worth of information. A construction engineer trained in cost seg must perform the study, so the complexity and cost of applying cost segregation is why most investors don't do it even though they would receive a huge tax benefit.
The most important things when considering cost seg are your cost benefit and that it's an engineered cost segregation study as opposed to a less intensive residual estimation or sampling study which can present IRS issues if too overzealous in reallocation. Back when the cost was $10,000-$25,000+ for a cost seg study it didn't make sense for a smaller building or rental property, but now the cost has come down considerably making it worth a look to every investor.
I'm a cost segregation specialist so if you'd like to learn more about the process or see some real numbers just let me know.
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