Cost segregation allows multifamily investors to significantly reduce their federal tax liability by taking their deductions over 5, 7, or 15-year periods, greatly increasing their cash flow. For example, if an apartment building worth $1 million was being depreciated over 27.5 years, an investor would be able to take a depreciation deduction of around $36,300 per year. If that depreciation was taken over a 7-year period, the investor would be able to take a staggering $142,000 annual depreciation deduction. Additionally, the Tax Cuts and Jobs Act of 2017 increased the depreciation bonus to 100% of eligible assets, and extended the depreciation bonus to used property. For example, if a taxpayer purchased an apartment building in 2019 for $2 million, and a cost segregation study classified $150,000 of that amount as 5-year personal property, the taxpayer could deduct $150,000 in that year. At a 35% tax rate, this would lead to a $52,500 reduction in the taxpayer’s federal income tax liability.

Cost segregation studies are typically done by engineering firms, rather than by accounting firms, as they involve the physical inspection of a property and a re-classification of various physical aspects of a building or buildings. It’s important to keep in mind that depreciation deductions only count the value of the building, not the land. In the thinking of the IRS, certain parts of a building deteriorate faster than others, so owners should be able to take these deductions at an accelerated rate.

Cost segregation studies can also be performed retroactively on properties acquired, remodeled, or expanded since 1987. This provides an incredible opportunity for property owners to reduce their income taxes, as they can take the entire unrecognized depreciation deduction in the year of the cost segregation study, instead of waiting to take the depreciation over the 5, 7, or 15-year depreciation term of the asset. This is often referred to as a “look-back” study. In general, cost segregation studies are considered to be cost effective for buildings worth $750,000 or more; otherwise, the time and expensive of the study may not be worth the potential tax deductions.

For more information on cost segregation and how it can help multifamily investors, please visit this article.

Cost segregation allows multifamily investors to significantly reduce their federal tax liability by taking their deductions over 5, 7, or 15-year periods, greatly increasing their cash flow. For example, if an apartment building worth $1 million was being depreciated over 27.5 years, an investor would be able to take a depreciation deduction of around $36,300 per year. If that depreciation was taken over a 7-year period, the investor would be able to take a staggering $142,000 annual depreciation deduction. Additionally, the Tax Cuts and Jobs Act of 2017 increased the depreciation bonus to 100% of eligible assets, and extended the depreciation bonus to used property. For example, if a taxpayer purchased an apartment building in 2019 for $2 million, and a cost segregation study classified $150,000 of that amount as 5-year personal property, the taxpayer could deduct $150,000 in that year. At a 35% tax rate, this would lead to a $52,500 reduction in the taxpayer’s federal income tax liability.

Overall, cost segregation is an incredibly effective way to reduce investor tax liability, and multifamily investors serious about maximizing their returns should make every effort to utilize it.

Cost segregation studies can be expensive and time consuming, and may not be worth the potential tax deductions for buildings worth less than $750,000. Additionally, cost segregation studies must be done by engineering firms, rather than accounting firms, as they involve the physical inspection of a property and a re-classification of various physical aspects of a building or buildings. Furthermore, cost segregation studies can only be performed on properties acquired, remodeled, or expanded since 1987, so investors who have owned their properties for longer than that may not be able to take advantage of the accelerated depreciation deductions.

The best strategies for multifamily investors to maximize cost segregation savings are to take advantage of the depreciation bonus offered by the Tax Cuts and Jobs Act of 2017, and to order a cost segregation study. The Tax Cuts and Jobs Act of 2017 increased the depreciation bonus to 100% of eligible assets, and extended the depreciation bonus to used property. This means that if a taxpayer purchased an apartment building in 2019 for $2 million, and a cost segregation study classified $150,000 of that amount as 5-year personal property, the taxpayer could deduct $150,000 in that year. At a 35% tax rate, this would lead to a $52,500 reduction in the taxpayer’s federal income tax liability. Additionally, ordering a cost segregation study can help investors identify assets that can be depreciated over shorter periods of time, such as 5, 7, or 15-year periods, greatly increasing their cash flow.

Sources:

• Cost Segregation
• Tax Cuts and Jobs Act of 2017

The best practices for multifamily investors to ensure cost segregation compliance are to hire a qualified and experienced engineering firm to conduct the cost segregation study. This firm should be able to sort relevant assets into property classes, justify/rationalize why each asset has been sorted into a particular class, and state and explain the cost basis for every asset while reconciling total allocated costs with total actual costs. This will reduce the chance that the IRS will find any issues with the study, and, if questions are raised, the firm will be able to answer them honestly and effectively.

For more information, please see this article on cost segregation.