Cost Segregation for SFR, and does Bonus Depreciation apply?

[Chuck Schmidt]

Looking at some SFR homes to purchase, in the $140K range ( 1 story, brick ranch, garage, 3br). Providing all the usual calculations work out ( rent, expenses, management) I have a few more questions on how to help my taxes.

Question 1, Would cost segregation be an advantage for depreciation? For an average $140K house, lot worth $20K, how much of the overall cost of the house would apply ( rough estimate - roof, AC, cabinets?, floors?, light fixtures, ...)? Guess $20-30K?

Question 2, If segregation works out, does the new Bonus Depreciation now apply? Can I deduct all short term depreciation in Yr 1?

Question 3, Is there an income cap to taking these deductions? (not a real estate professional)

Thanks, I have heard multiple opinions on this. 

Chuck

[Paul Caputo]

@Chuck Schmidt on a single SFR of this size it largely depends on your marginal tax rate if it makes sense or not. At a cost of $140K with land value of $20K you've got $120K to play with on depreciation. On average a SFR will have at least 8% tangible personal property - 5 year assets and 8% land improvements - 15 year assets. That's just average, some might be less, some may be more it depends on the facts and circumstances of the property. Just to make things easy let's say there's 10% of each, $12,000 tangible personal property and $12,000 land improvements and $96,000 residential rental property.

Using straight-line depreciation for a $120K rental you'd get $4,363 depreciation deduction each year for 27.5 years. The actual tax benefit of that depends on your marginal tax rate. At 37% that $4,363 deduction is worth $1,615 in tax savings each year. At 24% the same deduction is worth $1,047 in tax savings per year.

With cost segregation and 100% bonus depreciation you'd get $27,491 depreciation deduction the first year and $3,491 depreciation every year for the next 26.5 years. At 37% that's $10,172 in tax savings the first year and $1,292 in tax savings each remaining year. At 24% the same deductions are worth $6,598 in tax savings the first year and $838 in tax savings each remaining year. 

As you can see you're trading a much bigger benefit in the first year for a little less in the remaining years. At this size property it's debatable if spending $2,500 on a cost segregation study is worth it. At 37% you're getting $8,557 more in tax savings the first year and $323 less in remaining years than straight-line. At 24% you're getting $5,551 more in tax savings the first year and $209 less in remaining years. 

As you can see there is an advantage to using cost segregation, but it isn't huge. Now if you're looking at doing this on multiple SFR's it would absolutely make sense.

Yes, bonus applies on assets with a life of 20 years or less, so all the 5 year and 15 year assets qualify for 100% bonus. You can also opt to only do 50% bonus and do the other 50% over the normal 5 or 15 year schedules, or no bonus and do 100% on the normal 5 or 15 year schedules. 

On a new construction there would be more opportunities to maximize the benefits of cost segregation. We consult with builders and advise them on how to make small changes that will allow more assets to qualify for accelerated depreciation. Flooring is a great example. If it's considered permanent flooring like solid nailed in hardwood or grouted in ceramic tile that's a 27.5 year floor. If it's not considered permanent like carpet of floating laminate/engineered hardwood that's a 5 year floor. There are many little and big things that can be done to make cost segregation more effective at the pre-construction phase.