Cost Segregation Analysis - Pay a LOT Less in Taxes
Pay a LOT Less in Taxes - Cost Segregation Analysis
Do you want to pay less in taxes? That’s a dumb question, who doesn’t?
Well let’s talk about drastically reducing your tax bill or even eliminating it through buying and owning real estate by doing a Cost Segregation Study. It’s something that the wealthy and big business and developers have been doing for YEARS.
But first, real quick, my name is Jeff Chubb and I am a recovering Investment banker, turned real estate agent that has sold more than a 1,000 properties. We get calls, texts and emails from folks just like you who are looking to buy or sell an investment property in the Boston Metro area and I absolutely love it! So whether you are looking to make a real estate investment in the next 9 or 90 days… It doesn’t matter. Give us a call, shoot us an email or stop by YouTubeRealEstateAgent.com and fill in your information and we will reach out to you!
Let’s just remind everyone that I am not a CPA. I am just a real estate expert that have seen many friends and clients take advantage of this monumental opportunity. I recommend that you consult with your own accountant and advisor to ensure that you are able to utilize this additional depreciation on a timeframe that works for you.
So what is Cost Segregation? It is a tax deferral strategy that frontloads depreciation deductions in the early years of facility ownership. Segregating the cost components of your building into the proper asset classifications and recovery periods could result in significantly shorter tax lives of five, seven and 15 year spans. Instead of the standard 27.5 or 39 year depreciation period.
Think about it. Does it really make sense to depreciate a water heater over 27.5 years when it will most likely only last 10 years?
Deferring taxes with these strategies could help put cash back into your business or help utilize that savings to purchase another investment property. Ultimately cost segregation can give you the financial relief that you need to make it possible for you to invest in or build your real estate portfolio.
So cost segregation is a way for real estate investors to more quickly deduct the depreciation of a property - anything from a single family home to an office building or retail storefront.
Okay, so how does cost segregation work? In order to utilize this tax planning tool, you’ll first have to pay for a cost segregation study. This study will show you how to maximize the tax deductions from your investment property.
This firm will first complete a Feasibility Analysis on the property. They will first analyze the investment property to make sure it is a good candidate for cost segregation. By doing this, the team will study the different components of your investment property, including it’s plumbing fixtures, roofing, electrical systems, sidewalks, driveway, flooring and other materials used for the build.
Why do they do this? It’s because if you bought these items separately, you would be allowed under the IRS tax code to depreciate them over 5 to 15 years. But because they were already part of the building that you purchased, you are only allowed to depreciate them over 27.5 years for a residential building or 39 years for a commercial building.
During the study, the team of engineering and financial experts will separate each part of the investment property and place them in separate categories. You are then able to benefit from an accelerated depreciation timeline for some of the features in the building.
The second step is gathering all necessary information for the team to fulfill the study. This could include documents like the recent appraisal, inspection reports or even the closing documents from when you purchased the investment property.
Step three is the team analyzing the property. They will identify any operating costs that can be depreciated over either 5, 7 or 15 years. This is the reason why step two and providing the necessary documents is so important.
The 4th step is the team preparing a report that you and your accountants can use to determine how much you can save on your income taxes by utilizing this cost segregation strategy.
It’s important to note that cost segregation isn’t available on your primary residence. You can utilize cost segregation on residential real estate, but only for residential properties that you own as an investment. Not properties that you live in as a full-time residence.
So here is an example of a 3-family property in East Boston. It’s not an actual report. It’s an estimate to show how much you could possibly save and to help show someone why it could be a good idea to move forward with an analysis.
The purchase price is $1.8 million with the land allocation set at $568,973. This leaves an adjusted basis for the study at $1,231,027. And this makes sense, right? We can’t depreciate the land. We need to separate the building value from the land.
If an owner was to depreciate the property over the 27.5 years utilizing the straight line depreciation then they would be able to write off $44,764 per year. That’s an easy calculation, right? It’s the $1.231m divided by the 27.5 years.
Assuming a 37% tax rate, then that is a savings of about $15,680 per year. That’s not bad. But check out what the projections with the cost segregation analysis.
As a conservative estimate they see the owner being able to expense $189,476. This means that the tax benefit on year one would be $68,034.
Their optimistic analysis has them finding $280,929 worth of depreciation which means the tax savings in year one would be $103,943.
So essentially doing it this way, you could increase your tax basis on the current year taxes by $52,354 to $88,263. That is 50 to 90 grand of money in your pocket. Not a write off.
Let’s talk about some disadvantages.
There is a cost of doing this. Think in the ballpark of $2 to $4,000 dollars. So that is disadvantage number.
The second disadvantage is that the U.S tax code recaptures depreciation when the property is sold. You would never want to do this on a property that you plan on selling in a couple years. You would just end up having a big tax bill the year you sell. In other words, this tax strategy should only be utilized on property that you plan on holding for quite some time.
To confuse the situation more and to take this negative, but wrap it into a positive… Is if the property is sold by you heirs after your passing, then they would not need to pay back this recapture as the property would go through a cost basis analysis. This is in today's current tax code and an area where we are really starting to blur the lines of a full financial strategy and plan to lower your tax liability while you are living… And dead!
And the third disadvantage is that there are some costly penalties of overusing cost segregation. From experience I can tell you how unfun the IRS is to negotiate with during an audit. It is at the full discretion of the IRS auditor that you are working with. So make sure the company that you hire is reputable and will stand behind their work. You want to make sure the company has a team that is ready to support the study through legal hearings with expert testimony and that this warranty is provided at no additional cost.
Again, my name is Jeff Chubb with the Chubb Homes Team. I hope you found this video helpful and it has helped you learn a little about the tax advantages of investment real estate. Whether you are interested in buying an investment property in Massachusetts or anywhere else in the country, then it would be a true pleasure to help.
Yes, I personally can only help people in Massachusetts, but I do have expert agents that I work with all over the country. And it would be a true pleasure to make an introduction for you… At no cost to you obviously!
I love real estate. It’s the best way to build generational wealth and financial security for you and your family. If you have questions, then give us a call, shoot us an email or visit us at YouTubeRealEstateAgent.com. You can also find my information in the description below.
Oh… And just one more time… I am not a CPA. Make sure you talk with your accountant to see if this investment strategy is something that would work for you!
Until next time.