Many people think of cost segregation as a tax tool that can benefit commercial property owners. However, a cost segregation study can identify opportunities for faster tax depreciation for owners of residential rental properties, including apartments and rental homes, whether newly constructed, purchased or renovated. Far too often, this tax tool is overlooked in the multifamily property space.
Cost segregation frees dollars that can – in most cases – be invested immediately so that you can increase the property’s value over time. The study carves out (into 5-, 7-, and 15-year lives) certain qualifying portions of your building that are normally buried in 39- or 27.5-year categories. What’s more, the latest tax reform made cost segregation even more lucrative by doubling bonus depreciation from 50 percent to 100 percent, and this tax benefit applies to qualifying used property. This allows for much greater immediate tax deductions.
Cost Segregation Rental Properties Case Studies
The following examples demonstrate the impact of a cost segregation study on two residential rental properties.
Washington State Residential Cost Segregation Study
A cost segregation study on a $10.6 million residential building in Richland, Washington revealed roughly $3.5 million in first-year tax savings. Without a cost segregation study, the $10.6 million residential building built in 2019 would have generated a first-year depreciation of $392,593. By applying a cost segregation study, the property investors accelerated depreciation for the first year to more than $3.8 million. The chart below demonstrates the accelerated tax per class life.
| Study Type | Class Life | Percentage | Accelerated Tax |
|---|---|---|---|
| Cost Segregation | 5-Year | 27.75% | $2,957,011.49 |
| Cost Segregation | 15-Year | 7.51% | $799,852.24 |
| Cost Segregation | 27.5-Year | 64.75% | $94,085.44 |
| Total first-year depreciation with cost segregation | $3,850,949.17 | ||
| Total first-year depreciation without cost segregation | $392,592.59 | ||
| Total difference in depreciation first year | $3,458,356.58 |
Cost Segregation Study on a $13 Million Dallas Residential Complex
Without a cost segregation study, a $13 million residential complex in Dallas built in 2019 would have generated a first-year depreciation of approximately $477,000. By applying a cost segregation study, the property investors accelerate depreciation for the first year to over $4 million.
| Study Type | Class Life | Percentage | Accelerated Tax |
|---|---|---|---|
| Cost Segregation | 5-Year | 20.51% | $2,652,621.51 |
| Cost Segregation | 15-Year | 10.18% | $1,317,136.45 |
| Cost Segregation | 27.5-Year | 69.30% | $203,700.19 |
| Total first-year depreciation with cost segregation | $4,173,458.15 | ||
| Total first-year depreciation without cost segregation | $477,777.78 | ||
| Total difference in depreciation first year | $3,695,680.37 |
In both examples, cost segregation is based on a 40% tax bracket for federal and state taxes and performed on the ADR Asset Depreciation Range. Financial benefits are realized by maximizing net present value through deferring tax payments and using increased cash flow to strengthen your portfolio or scale your business. The tables above identify the difference between a cost segregation study and traditional 39.5-year capitalization.
Clearly, in these examples of cost segregation for residential properties, the acceleration in depreciation allows the property investors to reduce their tax liability and in turn increase their bottom line. By breaking down the building asset into components, cost segregation also aids in future benefits of abandonment, repairs, routine maintenance and overall asset management.
Engineered Tax Systems performs hundreds of cost segregation studies per month for property owners, providing a detailed engineering review of assets, including special purpose mechanical and electrical systems, decorative finishes, site improvements and any process related to special purpose construction.
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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 residential rental property.
