Cost segregation allows multifamily investors to reduce their federal tax liability. Generally, when it comes to investing in multifamily properties, investors want to take reasonable measures to expand their returns. One of the most effective ways to do this is to reduce their income tax liability via cost segregation, which greatly increases the rate at which investors can claim tax deductions. Generally, the IRS depreciation period is 25.7 years for multifamily real estate, whereas depreciation period for other commercial real estate is 39 years. However, cost segregation allows investors to take their deductions over a 5, 7 or 15 years period, greatly expanding their cash flow.
For example, if an apartment building worth $1 million was being depreciated over 27.5 years, an investor would be ready to take a depreciation deduction of around $36,300 per annum. If that depreciation was appropriated for a 7-year period, the investor would be ready to take a staggering $142,000 annual depreciation deduction. While it’s unlikely that a whole building would be re-classified as a 7-year depreciating asset, even $100,000- $200,000 of accelerated deductions can cause thousands a year in tax savings. However, so as to require these depreciation deductions over an accelerated period of time, building owners must require a cost segregation study.
How Cost Segregation Studies Actually Work?
Cost segregation studies are commonly done by engineering firms, instead of by accounting firms, as they involve the physical inspection of a property and re-classification of various aspects of a building. It is important to note that the depreciation deductions count only the value of the building, not the land.
Cost segregation studies can likewise be performed retroactively on properties acquired, remodeled or expanded since 1987. This brings a great opportunity for property owners to scale back their income taxes, as they will take the whole unrecognized depreciation deduction within the year of cost segregation study, rather than waiting to require the depreciation over the 5, 7 or 15 years. Generally, cost segregation studies are considered to be price effective for buildings worth $750,000 or more; in any case, the time and expense of the study might not be well worth the potential tax deductions.
Cost Segregation Depreciation Bonuses and the Tax Cuts
Starting in 2001, property owners were allowed to require a depreciation deduction for a particular portion of an eligible asset within the year they acquired it. Mentioned as a “depreciation bonus”, this was generally limited to new property and other assets with shorter (less than 20-year) lifespans. It permitted taxpayers to require a depreciation deduction of approximately 50% of the eligible asset within the year that it had been purchased.
Thus, cost segregation is an incredibly effective way to reduce investor liabilities , and multifamily investors serious about maximizing their returns should make every effort to utilize it.
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