The 3 Most Powerful Tax Saving Techniques for Investors: Part 2 - Cost Segregation

4/19/2017

In December 2016, we bought a small brand new fourplex in Provo for $550K. Our straight line depreciation amount would have been $700. After using a combination of powerful tax saving techniques, we were able to bump it up to $98,000, with a very little cost. Here's how we did it.

Read the previous article - Part 1: Bonus Depreciation

#2 - Cost Segregation

Whether you own a fourplex, an apartment building or a hotel, there are substantial tax savings that are hidden beneath your feet, within the walls and even in the landscaping and paving outside your building. By doing a cost segregation study, you can:

Get immediate tax savings
Increase cash flow by accelerating depreciation deductions and deferring income tax payments
Catch-up prior year accelerated depreciation. (Yes, even for the property you sold in the past!)

We invited our trusted cost segregation expert Brett Hansen from Cost Segregation Authority who have been a tremendous help to us and our clients to explain exactly what cost segregation is, and how the process works and how it could benefit you.

About Brett Hansen

Brett earned his MBA at Brigham Young University and Bachelors degrees in Japanese and Business Management from the same. Brett has been brokering and developing commercial real estate for over 12 years with direct experience in retail, multifamily, and senior living facilities. He brings with him a passion for identifying cost savings for investors, including the use of cost segregation and other tax credit advantages. Brett’s expertise in commercial real estate development, investment strategies, and construction provides a unique and valuable resource for his clients at Cost Segregation Authority.

WHAT IS COST SEGREGATION?

Cost segregation is a highly beneficial and widely accepted tax planning strategy utilized by commercial real estate owners and tenants to accelerate depreciation deductions, defer tax, and improve cash flow. Once used only by big-4 type accounting firms and the nation’s largest real estate owners, this practice has now become routine for commercial property owners of almost every size.

A Cost Segregation Study (CSS) is based on a detailed engineering-based analysis that is used to support the acceleration of depreciation deductions by identifying costs that can be allocated to shorter recovery periods; primarily 5, 7, and 15-year, as opposed to 27.5 (residential) or 39-year (commercial).

A quality study provides the documentation needed to defer substantial tax payments and greatly improve cash flow. It is important to note that a cost segregation study does not create new deductions, but increases deductions in the early years of ownership. This front-loading of depreciation allows the taxpayer to take advantage of the time value of money.

Cost Segregation is applicable to ANY income property, including leaseholds and can be applied retroactively to any building purchase or construction back to about 1987.

DIRECT BENEFITS

By increasing your depreciation deduction, you reduce your taxable income resulting in lower tax payments. Smart developers and investors use this savings to reinvest in more properties. See apartment example below:

OTHER BENEFITS

Bonus Depreciation
For property that is constructed (original use) and has an asset life of less than 20 years, a congressional stimulus inducement known as Bonus Depreciation will apply allowing you to take 50% (thru 2017) additional depreciation in Year 1. See example above. This is being phased out through 2019 so now is the time to take advantage.

Recapture Reduction
By having your building costs segregated, an investor can now allocate the sales price of the asset to the land and structure (appreciable components) and reduce the recapture on personal property (i.e. carpet) that was not sold at a gain.

1031 Exchanges
Cost Segregation and 1031 Exchanges work hand in hand to further defer the payment of taxes.

AVERAGE RECLASSIFICATION

The chart below shows the industry average reclassification of total capitalized costs based on asset type.

STUDY COSTS

Each study is priced according to its cost, size, complexity, location and other internal factors. These prices range anywhere from $2,000 to $200,000 or more depending on the investor/developer’s portfolio.

On average, a single, 4-story building study with moderate complexity will run about $15,000. The IRS prohibits pricing based on tax savings, but we do like to see at least an 8-10x return on the cost of the study whenever possible.

We will always run a benefit analysis on the property at no cost to determine if the cost segregation study is appropriate and provides enough benefit. About 95% of the time it does.

Brett Hansen
Cost Segregation Authority
(801) 884-8358
brett@costsegauthority.com
http://www.costsegauthority.com

A real-life example: a brand new fourplex built & placed in service in December 2016

To give you a better idea of the power of cost segregation study and bonus depreciation combined, here is a real-life example using our own rental property.

The IRS requires you to calculate depreciation over its 27.5 useful years using a different method called the modified accelerated cost recovery system. The math is a bit more complex than we'll want to dive into here, but to get a ballpark of your expenses you can enter the cost of your property and other variables into a property depreciation calculator at CalculatorSoup.

Let's look at Chart 1 below. The fourplex we bought and placed in service in December 2016 cost us $550,000 (roughly $460K for the building and $90K for the land). Since we bought it in December, our straight-line depreciation for 2016 would have been $700, and roughly $17K each year after that.

Now, let's say we bought it and placed in service in January 2016. As you can see in Chart 2, the deduction amount for 2016 would be greater because we would have owned and had the property running for the entire 12 months in 2016.

Chart 1

Chart 2

Now, let's look at the actual result of the cost segregation study done on our fourplex. Thanks to Cost Segregation Authority and the 50% bonus depreciation, our depreciation amount increased from $700 to $97,533!

Note: This is an extreme case as a result of the property being placed in service at the end of the year. The increase in depreciation amount will depend on the month the property is placed in service and The numbers on your study may look significantly different from our case.

Request a no cost, no obligation cost analysis for a cost segregation study provided by Cost Segregation Authority to see how much you can potentially save! (Or contact Brett directly and simply mention our name)
Don't forget to check out their website, especially their Common Questions page to better understand how it works and what to expect.

Sources:
How to Calculate Depreciation on a Rental Property - Realtor.com
How Rental Property Depreciation Works - Investopedia.com
Figuring Depreciation Under MACRS - IRS.gov
Claiming the Special Depreciation Allowance - IRS.gov

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