How to utilize Cost Segregation to your advantage

[James R aduna]

Hi BP Community,  

I was hoping to get some feedback on the best ways I can utilize cost segregation for my taxes this year and if anyone has recommendations for a Real Estate Accountant in the Los Angeles area that is well versed in this? I primarily invest in out of state SFH's and want to take advantage of this method. Thank you- James

[Kory Reynolds]

Cost seg studies don't come cheap, and the benefit is just playing on the time value of your money. Where I am (NH) most of the cost seg studies I have seen down cost the client somewhere between $6,000 and $15,000, with a $6,000 minimum. There are a few things to keep in mind for cost segs:

1) Is there an immediate / short term tax benefit? If the property was already generating tax losses you can't use due to Passive Activity Loss Limitations, then incurring additional losses by having the cost set study done may not benefit you at all.

2) Are you planning on selling anytime soon? If you sell, you will likely end up "recapturing" a good portion of the additional depreciation taken through the cost seg, so the you really just pushed off the associated tax a few years.

3) What is your marginal tax rate? If you are in a relatively low rate, you need a significantly higher write off for it to make sense. IE you would benefit at 22%, in order to pay back the cost of a $5k study you would need to accelerate $22k in depreciation and be able to take it. 

On proposals I have seen cost seg providers show the tax benefit as if you are in the 37% bracket, and with the assumption that you can take the entire loss.  This certainly provides a rosy Outlook, but be sure to apply it to your own tax situation.

Cost Segs are all about the time value of money, and they work much better for some types of real estate than others. The general rule we tend to see is that once the building cost approaches $1m, it may be worth it to pursue. They certainly are a powerful tool, but not a great fit for all real estate applications. In your situation with SFH it seems unlikely that it would be worth the money.