Depreciation Benefits of Cost Segregation and Accelerated Depreciation

by | Sep 15, 2022

Benjamin Franklin was quoted in 1789, “…nothing can be said to be certain, except death and taxes.”  I’m not going to suggest that we can avoid either of these, but I will suggest that investing in real estate through the syndication model can certainly help you kick the tax can down the road especially if you leverage cost segregation and accelerated depreciation.  In this brief article, I’ll walk through two great strategies that real estate investors can use to help decrease their tax burden at least temporarily.

What is Depreciation?

Depreciation is an expense that investors get to count against their income because real estate assets decrease in value over time from wear and tear.  Residential real estate allows you to depreciate the asset over 27.5 years, and commercial real estate allows you to depreciate the asset over 39 years. It’s important to note that the land cannot depreciate so only a portion of the total purchase price can be depreciated.  As an example, let’s say you purchase a $375,000 house, and the land is worth $100,000.  You could then apply $10,000 in depreciation expense against your investment income every year for the next 27.5 years ($375,000 minus the land cost of $100,000 divided by 27.5 years).  If you are personally in a 20% tax bracket, this would save you $2,000 per year in taxes.  Wouldn’t you agree that this is very cool?

What is Cost Segregation?

 A cost segregation study allows you to break the asset down into smaller units that depreciate at a faster rate so you can take advantage of the tax benefits of depreciation sooner.  As an example, carpet and refrigerators might depreciate over 5 years, and appliances and furniture might depreciate over 7 years.  To leverage this strategy, a 3rd party cost segregation special must be contracted to perform the full analysis of the property, but you can clearly see how this would be advantageous to your tax strategies.

What is Accelerated Depreciation – 100% Bonus Depreciation?

The Tax Cuts and Jobs Act of 2017 adjusted the existing tax law to allow an incentive to immediately deduct 100% of the itemized depreciation expense in the first year of ownership versus deducting it over the normal 5-, 7-, or 15-year depreciation periods.  This was a tremendous win for real estate investors, and it provides a unique opportunity for the passive investor to take advantage of tremendous passive losses the first year they invest in an investment through the syndication model.

In the same example as above ($375,000 house with land worth $100,000), your depreciation expense could be closer to $100,000 in the first year compared to the $10,000 per year for $27.5 years.  Imagine the tax savings you could have at the end of the year in this scenario.  Now, imagine what that could look like if you were buying $20MM or $50MM apartment complexes.

Please note that the example above is shared just to show the power of this strategy, not to suggest any specific tax guidance for you personally.  I am not a tax professional, and this is not intended as tax advice.  I do, however, encourage you to work with your tax advisor to see how these strategies can work for your unique situation.

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