If you own or invest in multifamily properties such as rental units, you are focused on increasing the property’s value over time. One of the most effective ways to accomplish this is to decrease your tax liability through federally approved tools like cost segregation. While cost segregation is well-known among other commercial property owners, it is sometimes overlooked in the multifamily property space. While the fundamentals of cost segregation are the same for all commercial properties, there are differences in IRS rules and strategies for attaining maximum tax benefits with multifamily units.
Through cost segregation, multifamily property owners can separate property components so that items such as land improvements and personal property can be separately depreciated over shorter recovery periods for cost savings. The process of identifying assets and determining which costs qualify for accelerated depreciation is a critical tax-savings tool that also increases your cash flow.
The Tax Cuts and Jobs Act (TCJA) of 2017 made cost segregation even more lucrative. Since 2001, property owners have been able to take a depreciation deduction of 50% for certain portions of eligible assets in the year they acquired it. This bonus was limited to new property and other assets with a shorter lifespan. Bonus depreciation enacted as part of the latest tax reform allows for 100% first-year bonus depreciation on certain depreciable business assets with a life of 20 years or less.
See related blog: Tax Reform Changes Regarding Cost Segregation.
While other commercial property typically has an IRS depreciation period of 39 years, multifamily property generally has a depreciation period of 27.5 years. Cost segregation allows you to take deductions over 5, 7 or 15 years. If you are able to reclassify portions of your building to take tax deductions at 5 or 7 years, the accelerated tax deductions could mean thousands of dollars per year in tax savings. What’s more, if you are making immediate improvements upon acquiring a property, these cost savings can offset investments that can’t be recouped through rent increases. And, since multifamily property investors often hold properties for up to 10 years before selling at a profit, the accelerated depreciation timetable is an especially valuable asset for their investment.
Cost Segregation Studies: Identifying Property Assets for Accelerated Depreciation
The way to determine how quickly you can accelerate depreciation schedules is through a cost segregation study. Engineering and tax professionals are needed to conduct the study to determine which aspects of your buildings(s) can be reclassified. A qualified engineer will use blueprints and cost reports to determine whether property can be reclassified for tax benefits. This physical inspection will sort relevant assets into property classes and justify why each asset has been assigned to a particular class. The study will also state and explain the cost basis for every asset.
To learn more about the information that needs to be collected for a cost segregation study, read our related blog: What Information Needs To Be Collected For A Cost Segregation Study?
If you have not had a cost segregation study performed in the past, you can still benefit through retroactive studies. As long as the property was acquired, remodeled or expanded since 1987, you have an opportunity for savings through reduced income taxes. You don’t even have to wait to take the depreciation—you can take the unrecognized depreciation deduction the year the cost segregation study is performed.
Depreciation Recapture—a Balancing Act
Cost segregation offers multifamily property owners and investors a tremendous opportunity for cost savings. However, it is important to note that the IRS considers any capital gains from the sale of depreciated property as personal income that must be taxed at your ordinary income tax rate, also known as depreciation recapture. Most investors will find they can still benefit from cost depreciation. By working with your tax professional, you can determine whether the ability to invest in additional properties today outweighs what you must pay the IRS when you sell.
The engineering and tax professionals on the cost segregation team at Engineered Tax Services have helped real estate owners and investors significantly increase their cash flow by identifying and reclassifying assets of their building for faster depreciation. Request a Free Benefit Analysis to identify an estimated benefit and ensure a cost segregation study makes sense for your property.
To learn more about cost segregation studies for real estate owners and investors, call Engineered Tax Services at (800) 236-6519 or visit cost segregation page for more information.