Real estate owners and investors who want to maximize the cash flow from their investments can take advantage of the option to accelerate their depreciation deductions for tax purposes – but may wonder when this can and should be done.
Here’s the answer: just about any point during the time you own depreciable real estate can be a good time to accelerate your deductions as long as the property is not already highly depreciated. That means any time during the first ten to fifteen years of ownership.
That said, most of the cost segregation studies that cross my desk are lookback studies, where the property owner and their tax advisor have realized long after the building was put into service that cost segregation could generate significant current cash flow.
Although lookback studies are beneficial, the optimum time to apply cost segregation is as soon as one of these trigger events occurs, so accelerated depreciation occurs immediately rather than catching up later.
New construction. Many CPAs I’ve talked with think this is the only time that cost segregation can be applied. This is incorrect, but it is the best time since the property owner will start benefiting from accelerated depreciation right from the beginning. There will be no catching-up to do.
Purchase. Whenever a commercial or multi-family residential building is purchased, cost segregation should be considered as a tax deferral strategy.
Acquisition via exchange. When a building is acquired via a tax deferred exchange, and if there is an amount paid over and above the exchange basis of the relinquished property, then the incremental cost basis above the exchange basis amount may be cost segregated. It is not advisable to cost segregate the exchange basis itself because that could result in the IRS disallowing the tax deferral sought through the exchange. That’s because segregating assets into different recovery periods undoes the “like kind” aspect of the property being exchanged. See my post on cost segregation and exchanges [need link for this] for more on that.
Renovation or expansion. Improvements of $500,000 to $1 million or more or can be good candidates for cost segregation. Typically, they will include a good deal of non-structural assets that can be reclassified as short-term assets.
Leasehold improvements. If a landlord pays for tenant improvements, or if a tenant pays for them, someone has an investment that may be a good target of opportunity for tax deferral. Tenant improvements, whether part of a study performed on an entire building, or as the entire subject of a study, can be cost segregated with rewarding results. See my post on tenant improvements [need link for this] for more.
Step up in basis. If a partner is bought out or a co-owner passes away, there may be a significant dollar amount in stepped-up building basis. When this occurs it can trigger a cost segregation opportunity if it is on the books as a 27.5 year or 39 year asset. The entire property can be cost segregated and the results allocated to the asset represented by the step up.
If you have let any of these trigger events slip by, don’t despair. It may not be too late to take advantage of the tax deferral option available via cost segregation. Other than new construction, all of these scenarios can be dealt with effectively via a lookback study.
Oh, and it’s even possible to generate tax savings by cost segregating a property after sale. Click here to learn more.
If you own and invest in commercial real estate or apartments, and have not yet looked into cost segregation, take a closer look to see if you can use it to significantly improve your cash flow. It’s easy to get a complimentary estimate of tax benefit that you can discuss with your tax advisor.
Keep these 6 Tax Deferral Triggers at your fingertips: Download this infographic:
Jeff helps real estate owners increase their cash flow. He started his career as a Financial Analyst with the Irvine Company, and worked in various management/executive positions in the mortgage industry for many years. He's been a Cost Segregation consultant for several years and is considered one of the industry's top experts in TPRs. As Director of Business Development for Bedford Cost Segregation, Jeff helps his clients increase cash flow by accelerating their depreciation deductions, and by writing off assets that no longer need to be depreciated under recently changed tax rules. Jeff has a B.S. in Economics from Claremont McKenna College and an MBA with an emphasis in Finance from UC Berkeley.
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