Narrative
In April 2021, investors acquired a historic apartment complex in Tustin, California, to capitalize on the growing residential real estate market. The property comprises four buildings spanning approximately 11,216 square feet of living space. Originally constructed in 1921, this charming complex features 22 residential units designed to offer modern amenities while preserving its historic character.
The buildings have been thoughtfully maintained and updated over the decades, featuring contemporary electrical systems, modern HVAC equipment, energy-efficient water heaters, and standard apartment fixtures including refrigerators, dishwashers, and in-unit laundry connections. The property also includes well-maintained grounds with paved parking areas, sidewalks, landscaping, and recreational amenities including a swimming pool with deck facilities.
The owners engaged Engineered Tax Services (ETS) to perform a comprehensive cost segregation study of the property. This strategic decision was made to identify and reclassify specific assets that could be depreciated over shorter time periods, thereby accelerating tax deductions and improving cash flow. This case study outlines the cost segregation methodology employed and its substantial financial impact on the property's operation.
Objective
The primary objective of the cost segregation study was to identify and classify the apartment complex's assets to optimize the owners' tax savings. With a total depreciable basis of $3,904,626, ETS aimed to reclassify building components into shorter depreciation life categories, providing significant immediate and long-term financial benefits through accelerated depreciation. The study also sought to provide proper documentation to support these reclassifications in the event of IRS scrutiny.
Methodology
ETS employed a detailed, engineering-based approach, which included:
- Physical Inspection: conducting a thorough site visit to identify and photograph the property's components
- Document Review: examining architectural plans, construction documents and accounting records
- Cost Analysis: applying engineering principles to allocate costs to specific asset classifications
- Depreciation Calculation: calculating depreciation using IRS-accepted methods such as the Modified Accelerated Cost Recovery System (MACRS)
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Discover MoreAsset Allocation
5-Year Class Life
Total Depreciation Allocation: $1,016,826 Percentage of Total Depreciable Basis: 26.04%
5-year class life assets identified in this study include:
- Apartment appliances (refrigerators, dishwashers, microwaves, garbage disposals)
- Kitchen and bathroom fixtures (cabinets, countertops, mirrors, vanities)
- Electrical equipment and panels (distribution panels, outlets, specialized lighting)
- Laundry equipment and hookups
- Floor coverings (vinyl plank flooring, carpeting)
- Window treatments (blinds, fixtures)
- Communication and security systems
15-Year Class Life
Total Depreciation Allocation: $312,508 Percentage of Total Depreciable Basis: 8.00%
15-year class life assets identified in this study include:
- Site improvements (paved parking areas, concrete sidewalks, asphalt paving)
- Recreational facilities (swimming pool, pool deck, pool equipment)
- Site utilities (bollards, mailbox clusters, site lighting)
- Landscaping improvements (lawns, planted areas, fencing)
- Exterior site concrete work
27.5-Year Class Life
Total Depreciation Allocation: $2,575,292 Percentage of Total Depreciable Basis: 65.95%
27.5-year class life assets identified in this study include:
- Structural components (walls, roof structures, building footings)
- Building systems (HVAC distribution, plumbing systems, electrical distribution)
- Permanent fixtures (bathroom fixtures, built-in fixtures)
- Interior construction (drywall partitions, ceilings, permanent flooring)
- Doors and windows as part of the building envelope
- Exterior finishes (stucco, roofing materials)
Class Life Details:
Summary
The cost segregation study for this historic apartment complex in Tustin, California, demonstrates the substantial financial advantages of strategic tax planning for residential real estate investments. By reclassifying property components from the standard 27.5-year straight-line schedule to shorter depreciation categories, the study enabled accelerated depreciation that resulted in significant tax savings and improved cash flow.
The total increase of depreciation was $1,150,075 in 2024 alone, providing immediate tax benefits to the property owners. Over 34% of the building's depreciable assets were successfully reclassified into 5-year and 15-year categories, creating a powerful tax advantage that continues to compound annually.
This case study illustrates how cost segregation can significantly enhance the financial performance of residential real estate investments, particularly for historic properties with substantial capital improvements and modern amenities. The detailed engineering analysis provided by ETS ensures these tax benefits are sustainable and defensible under IRS scrutiny, making this a valuable long-term tax strategy for the property owners.
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