Cost Segregation For Residential Buildings

It’s well-known that cost segregation studies are ideally suited for commercial real estate. But Cost Segregation is also good tax strategy for residential real estate too? You bet!

As your building ages, it loses value. That’s called depreciation. When you do a cost segregation study, it classifies your building’s components (like the lighting system) into shorter recovery periods so you can write off the components faster in your taxes and reduce taxable income. The study carves out certain qualifying portions of your building into five-, seven- and 15-year lives that are normally accounted for in 39- or 27.5-year categories.

Cost segregation frees dollars that can – in most cases – be invested immediately so that you can increase the property’s value over time. 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.

While commercial real estate is subjected to a 39-year depreciation period, residential real estate can be depreciated over 27.5 years from the time when it first becomes rentable.

Some accountants depreciate apartment complexes or other multifamily housing property over 39 years, but they’re mistaken. Residential rental property should be depreciated over a 27.5-year recovery period. Only nonresidential real property should be depreciated over 39 years.

What constitutes residential rental property? Buildings or structures for which 80 percent or more of the gross rental income is rental income from dwelling units. Therefore, an apartment complex, which falls within the definition of residential real estate, should be depreciated over the shorter 27.5-year recovery period. Too often, residential real estate owners and investors fail to understand the terrific advantage a cost segregation study could deliver.

You can have a cost segregation study done on your building anytime, but it’s best to do it right after you’ve purchased your property so you can write off assets removed during remodeling or replacing building components. If you do a study right after acquiring your building, you’ll be able to claim bonus depreciation, which can create a write-off as high as 30-40% of your total purchase price in the first year.