Unlocking the Power of Cost Segregation and Bonus Depreciation in Real Estate Investing
Disclaimer: We are not accountants, lawyers, or financial advisors, so please consult your own team of professionals about the topics covered in this article.
Real estate investing offers numerous tax advantages, but not all investors are taking full advantage of these benefits. In this article, we’ll explore the concepts of cost segregation and bonus depreciation, two powerful tax strategies that can significantly accelerate depreciation and maximize tax savings for real estate investors.
What is Depreciation?
For tax purposes, the federal government considers all investment properties as losing value each year (depreciation). The IRS allows you to count the depreciation of your investment as an expense each year on your taxes. This depreciation expense is spread out over 27.5 years for a residential property and 39 years for a commercial property.
What is Cost Segregation?
Cost segregation is a study that’s performed by an engineer who evaluates the components of the building and assigns a different tax life to each. The non-structural components have a 5, 7, or 15-year life, while structural components have a 27.5-year life. By spreading the cost over a much shorter period, the amount of your depreciation expense goes up significantly in the first few years of your ownership of the property. This is called accelerated depreciation.
What is Bonus Depreciation?
Bonus depreciation is an additional benefit on top of accelerated depreciation. It allows you to take the components with a 5-15 year lifespan and expense it all in one year instead of spreading it out. For properties purchased after September 27, 2017, you can take 100% of the cost-segregated components as a depreciation expense in Year 1.
How to Maximize the Benefits of Cost Segregation and Bonus Depreciation
To take full advantage of these losses and offset W2 or 1099 income, you need to be actively involved in your rental properties. For long-term rentals, you need a status called Real Estate Professional Status (REPS). For vacation rentals, you need to materially participate in the rental activity.
What is This Really All About?
The reality is that cost segregation/bonus depreciation only shifts the timing of your depreciation expense. It doesn’t increase your depreciation expense overall. The answer is compound growth. By front-loading your tax savings and getting your money working for you sooner, your money grows much faster than if you were to take those tax savings in small increments over a longer period of time.
Key Takeaways
Maximizing your depreciation expense while you still own the property is in your best interest. If you use a 1031 exchange when you sell the property, you’ll get to continue to defer paying the taxes on your gains, allowing you to maximize your tax savings early on in your investing career to supercharge your growth. Contact DIY Cost Seg with any questions you may have regarding Cost Segregation and Bonus Depreciation!