Maximizing ROI: How Cost Segregation Can Boost Your Real Estate

Real estate investors sometimes make the mistake of thinking about real property as a single, indivisible asset. They might not realize that, for tax purposes, real property consists of multiple types of assets with a wide range of useful lives.

Your property isn’t a monolith. It encompasses a building shell, infrastructure, flooring, roofing, lighting, landscaping, and so much more. With a cost segregation study, real estate investors can get a greater return on investment on their properties.

What Is Cost Segregation?

Cost segregation analysis in real estate is a tax strategy that real estate investors can use to maximize the tax benefits of their properties. Depreciation allows investors to write off the cost of real property assets over the course of their useful life. With cost segregation, you can take full advantage of accelerated depreciation opportunities.

Generally, you cannot deduct the entire cost of a capital asset in the year you acquire it or place it in service. The deductions must be taken over a certain number of years, based on the IRS’ estimate of an asset’s average “useful life.” The amount of time it takes to fully depreciate the cost of an asset is known as its “recovery period.” Under the General Depreciation System (GDS), real property as a whole is automatically assigned a standard lengthy recovery period – 39-Year for commercial property, and 27.5-Year for residential rental property.

However, many types of assets commonly found in both residential and commercial real estate investment properties have been assigned shorter recovery periods than 27.5/39 year. By breaking out the shorter-lived assets within a property, taxpayers can benefit by accelerating their depreciation.

Recovery periods for these assets often fall in 5-Year, 7-Year, or 15-Year categories:

Taking advantage of accelerated depreciation allows investors to reduce their tax bills and boost their bottom lines.

What Is a Cost Segregation Analysis in Real Estate?

Taking full advantage of depreciable assets requires a cost segregation analysis. Real estate investors can retain a professional specializing in this field to thoroughly study their holdings and identify all assets eligible for accelerated depreciation. The specialist will review all relevant property documents and conduct site visits to develop an extensive accounting of your holdings.

The final report will include a meticulous breakdown of all acceleratable assets classified according to the Modified Asset Cost Recovery System (MACRS). Rather than depreciating the entire property over 27.5 or 39 years, cost segregation will permit the depreciation of many assets over the aforementioned 5, 7, or 15-Years.  New deductions are not being created, but by front-loading depreciation, and getting those deductions sooner, investors can take advantage of the time value of money.

You can conduct a cost segregation study at numerous points in the life of a property, including:

• Acquisition of a property (may be through a 1031 Exchange)
• New construction of a property
• Renovations on an existing property

What Are the Benefits of a Cost Segregation Study in Real Estate?

The basic principles of cost segregation are fairly intuitive. This might lead some real estate investors to believe they could simply conduct their own cost segregation study. This is a mistake – “doing it yourself” can have impactful consequences.  At best, you might not maximize the benefit to which you are entitled.  At worst, you might make significant tax errors that will call the validity of your study into question.

Cost segregation specialists have extensive backgrounds in construction and tax. They know how to:

• Conduct a thorough site inspection to identify all depreciable assets;
• Assign costs to each asset;
• Classify each asset in the appropriate recovery group; and
• Ensure that their conclusions comply with auditing best practices and IRS regulations.

By retaining cost segregation consultants, you can ensure that you will receive a comprehensive and accurate report that takes fully leverages your holdings while remaining defensible in the unlikely event of an audit.

How Can Cost Segregation Help Maximize ROI in Real Estate?

If you depreciate all assets according to the automatically assigned period of 27.5/39 Years, you’re missing out on the power of accelerated depreciation.

Cost segregation allows you to:

• Depreciate a larger portion of the property’s cost or basis upfront, rather than waiting years to do so;
• Claim larger tax deductions in the early years of an investment;
• Improve your cash flow by reducing your tax liability; and
• Free up more capital to invest in new or existing projects, giving you an advantage over other investors.

How Can Capstan Tax Boost Real Estate ROI?

At Capstan, our team of tax and engineering professionals can perform real estate cost segregation analyses for all real estate verticals. From complex commercial properties to single-family residences, we can handle it all. Contact us to learn more about how we partner with real estate owners and their accounting professionals.