Many investors are looking for ways to optimize returns and using accelerated depreciation in real estate is a great way increase cash flow. At Corporate Tax Advisors, we provide cost segregation services to both residential and commercial real estate investors across the country, so we’re happy to share our knowledge on this topic in this blog.
If you want to talk about your specific situation, we encourage a free cost segregation consultation with our team as well.
What Is Depreciation in Real Estate Investing?
With real estate investing, income comes from tenant rent payments and like with any other type of business, a rental property has a number of expenses that offset the income to arrive at profit for the purposes of income taxes.
Depreciation is a little bit confusing in that there is no cash movement associated with it like paying for a new roof or monthly payments to a landscaping service.
However, the cost of a property deteriorating over time is real and as with many things accounting, the IRS wants that expense recognized within the period in which it occurs.
So depreciation in real estate is the allowable deduction the owner can take each year to compensate them for the decrease in the value of the property over time for things like aging and wear and tear.
Accelerated depreciation is a method that allows property owners to deduct a larger portion of a property’s value as an expense in the earlier years of ownership.
What Is the Difference Between Accelerated Depreciation and “Standard” Depreciation?
Standard depreciation is collected over 27.5 years for residential properties and 39 years for non-residential properties.
Under the IRS Cost Segregation Guide, Accelerated Depreciation allows a reclassification of assets to have a shorter life than that of the useful life of the property. This can generally be around 20% of the property basis that is moved to shorter asset lives meaning more usable expense to offset income each year.
What Types of Properties Can Use Accelerated Depreciation?
Generally speaking any commercial real estate or residential rental property that is generating revenue or is used in the production of goods and services can benefit from accelerated depreciation.
What Types of Items Are Eligible for Reclassification?
Land Improvements
Items that improve the land around your property can be moved to 15 year asset life. This would include sidewalks, driveways, patios, structures without walls, and landscaping.
Personal Property
Personal property or 5 year assets are items that are generally found inside the building. This would be decorative lighting, millwork, decorative trim, and removable flooring.
How Does Using Accelerated Depreciation Help Investors and Investment Returns?
Accelerating the depreciation period frees up capital by reducing your taxes owed. You can use it to invest in additional properties or renovate existing properties.
The time value of money is the entire idea behind cost segregation. The sooner you can have the money you invested in the original property back, the more valuable it is. So moving 15-year or 5-year asset lives means the value of those components of a property is usable as an expense much sooner.
You may interested in reviewing our cost segregation study examples.
How Does a Cost Segregation Study Help Investors Start Using Accelerated Depreciation?
Utilizing accelerated depreciation begins with having a cost segregation study done on the property by our tax credit advisors. After thoroughly reviewing blueprints, site plans, and cost data OR having your building scanned for 3D modeling via our Cost Seg Survey partnership with IPX, we can produce the report you’ll need to support your tax deductions.
CTA is able to provide a detailed report that recategorizes assets as either personal property, land improvements, buildings and structures, or land. Each of these classifications has its own tax depreciation standards and schedule. This allows us to then accelerate the depreciation of these categories and take advantage of the deductions sooner than if the property remained categorized and depreciated as a single asset.
How Does Accelerated Depreciation Impact Your Real Estate Taxes?
To be clear, standard or accelerated depreciation does not impact your annual real estate tax payment. Cost segregation is not a tool to argue with your local tax authority on the assessed value of your property.
It gives you more expenses to use on your business income taxes (or personal income taxes) when you have rental properties.
How Can You Start to Use Accelerated Depreciation to Increase Your Real Estate Investment Gains?
It all starts with a free consultation with our team of cost segregation experts. We’ll be happy to discuss your situation and confirm whether or not a cost segregation study could be of benefit to you.
If it is, we provide those services and are happy to coordinate with your CPA for your actual filings. We only invoice for our work once your savings are determined so it’s an ROI-positive step you can to take increase your investment returns on real estate.
