Cost Segregation for SFR, and does Bonus Depreciation apply?

Question

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 · Answer

@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.

Michael Plaks · Answer

@Chuck SchmidtQ1. Yes, cost segregation could be an advantage, depending on your numbers. The price for a professional study starts at $2k, so it is not cost effective for typical SFHs. Your option is to do some simplified in-house cost segregation and bear the risk of an IRS challenge to it.Q2. Debatable. Some tax professionals on this forum, including myself, say yes. Others say no.Q3. There is no income cap on depreciation. There is an income cap on deducting losses resulting from all deductions combined, including depreciation. Starts phasing out at $100k and drops to zero at $150k.

Michael Plaks · Answer

@Chuck SchmidtWhether or not you're crazy is a question for your wife. ;) Speaking of whom - she does not need a real estate license to qualify for RE Pro. Conversely, having a license does NOT qualify her by itself. Being a licensed agent and being a RE Pro are two unrelated things. There's been a lot of posting about it these last few days - browse the forum to see the discussions.You do not need "more research" on the bonus depreciation issue. It's a brand new and unsettled issue that will remain controversial for some time. Maybe a short time, if the IRS decides to conclusively clarify it. More likely, however, for a very long time, including future litigation. Basically, you have to choose your religion and have faith in it. Both sides have valid arguments, but only one of them is right. (I'm sure it is my side.) If it is new construction, your need for cost segregation is MUCH less actually, because your have a predetermined cost of specific items. What you need from your builder is an itemized cost of construction, separating appliances, carpets, landscaping etc.

Craig Ts · Answer

@Paul Caputo very good information and example! For cost segregation, does one need to enter building or specification from builder is sufficient ?

Chuck Schmidt · Answer

Thanks for the inputs. A little more info. The builder I am working with only has 5 floor plans and builds to rent. I'm trying to convince them to pay for the cost segregation and offer as a benefit to the buyer. He has several of the same floor plan available in different parts of town. Same bill of materials, I think (except for land cost) they would be the same cost segregation. Time to find out how much of the house cost would be covered. If it is $5k, probably not worth it. If it is $20K ( x 2-3 houses I am looking at), that could put a dent in my large tax bill. I am hearing different opinions on the bonus depreciation also. More research needed. I heard Tom Wheelright (sp?), the financial guy for Robert Kyosacki say yes. I heard another CPA on Kathy Fetke's show say no. I explained all that is going on to my wife, she may offer to get her real estate license, therefore we file taxes jointly and have a real estate professional... again, more reading to do.I would definitely be way over the $150K income exclusion for now, but am hoping to retire soon and drop my income to about $100K. Maybe some of this will be more applicable then.So sounds like more research to do. I appreciate all opinions. LMK if I am crazy.Chuck

Jason Dillard · Answer

1. Not enough meat on bone to justify price of cost segregation until you get to about 500k properties.2. Different parts of the property get a shorter schedule. As far as I know, only personal property can get it all in one year. ex in our last one: each $12 stripe in parking lot went down to 5 years from 27.53. Yes, there is a cap. You would need to get your CPA to tell you what yours is. You can search "full time real estate professional" on irs.gov to learn more. If you have a great job, you may have to make your wife work enough hours per year to qualify.