Beyond Bending Tell You How
Investing in rental property can be a lucrative business venture, but it also comes with a lot of expenses. One of the major expenses that rental property owners face is taxes. However, with the right tax strategy, owners can significantly reduce their tax liabilities and increase their cash flow. One such strategy is cost segregation.
Cost segregation is a tax planning strategy that allows rental property owners to accelerate depreciation deductions and reduce their income tax liabilities. It involves separating the components of a rental property into different categories based on their useful life and assigning them a different depreciation schedule. This results in a shorter recovery period for certain assets, which means owners can claim higher depreciation deductions and reduce their tax bills.
How does Cost Segregation work?
The process of cost segregation involves a detailed analysis of the rental property to determine which assets qualify for accelerated depreciation. A cost segregation study is usually conducted by a qualified professional, such as a certified public accountant or an engineer. The study involves a physical inspection of the property and a review of its original construction plans and cost records.
The professional then identifies the components of the property that qualify for shorter recovery periods and assigns them to the appropriate asset class. For example, assets such as carpets, window treatments, and appliances may qualify for a shorter recovery period of five years instead of the standard 27.5 years for residential rental property. This means the owner can claim a higher depreciation deduction for these assets in the first few years of ownership, resulting in significant tax savings.
What are the Benefits of Cost Segregation?
Cost segregation offers several benefits to rental property owners, including:
1. Increased Cash Flow
By accelerating depreciation deductions, owners can reduce their tax liabilities and increase their cash flow. This means they have more money to reinvest in their rental property or use for other business ventures.
2. Reduced Tax Liability
Cost segregation allows owners to claim higher depreciation deductions in the early years of ownership, which reduces their tax liabilities. This means they can keep more of their rental income and reinvest it in their property.
3. Improved ROI
With cost segregation, owners can improve their return on investment (ROI) by reducing their tax liabilities and increasing their cash flow. This means they can achieve a higher ROI in a shorter period of time.
Who Can Benefit from Cost Segregation?
Cost segregation is beneficial for all rental property owners, regardless of the size of their property. However, it is especially beneficial for those who:
1. Have Newly Constructed Properties
Newly constructed properties usually have a higher cost basis, which means there are more assets that qualify for accelerated depreciation. This means owners can claim higher depreciation deductions and reduce their tax liabilities.
2. Have Recently Acquired Properties
Owners who have recently acquired rental properties can benefit from cost segregation by identifying assets that were previously overlooked and assigning them to the appropriate asset class. This means they can claim higher depreciation deductions and reduce their tax liabilities.
3. Plan to Sell their Property
Owners who plan to sell their rental property can benefit from cost segregation by reducing their tax liabilities and increasing their net proceeds from the sale. This means they can achieve a higher return on their investment.
How to Conduct a Cost Segregation Study?
Cost segregation studies should be conducted by qualified professionals, such as certified public accountants, engineers, or cost segregation specialists. The process involves the following steps:
1. Physical Inspection of the Property
The professional conducts a physical inspection of the rental property and identifies the assets that qualify for accelerated depreciation. They also review the original construction plans and cost records to determine the cost basis of the property.
2. Asset Classification
The professional assigns the assets to the appropriate asset class based on their useful life and depreciation schedule. They also determine the cost basis of each asset and calculate the depreciation deductions for each asset class.
3. Preparation of Cost Segregation Study Report
The professional prepares a cost segregation study report that outlines the findings of the study and provides a detailed breakdown of the assets and their respective depreciation schedules. The report also includes a calculation of the depreciation deductions for each asset class and the resulting tax savings.
How Much Does a Cost Segregation Study Cost?
The cost of a cost segregation study depends on several factors, such as the size and complexity of the rental property, the type of assets involved, and the professional conducting the study. However, the cost of the study is usually outweighed by the tax savings generated by the strategy.
Conclusion
Cost segregation is a powerful tax planning strategy that can help rental property owners reduce their tax liabilities and increase their cash flow. By separating the components of a rental property into different categories and assigning them a different depreciation schedule, owners can claim higher depreciation deductions and reduce their tax bills. While the process of cost segregation can be complex, it is best conducted by a qualified professional who can identify all the assets that qualify for accelerated depreciation and prepare a detailed cost segregation study report.
