1. Cost Segregation Defined
A cost segregation study is the practice of allocating the cost basis of property to various components of your rental real estate, so instead of allocating 100 % of the value to building and land a cost segregation study allows us to segregate, or divide the cost basis between personal property, land improvements, building and land.
That means that when we’re done with a cost segregation study, we’re gonna have value allocated to five year, seven year, fifteen year and twenty seven and a half year property, rather than allocating all of our value only to twenty seven and a half-year property. The results of this allocation mean that we will be able to depreciate components over a faster time period. Depreciating parts of the building faster generates large, non-cash, expenses and reduces taxes.
2. Bonus Depreciation
The second tip is that we can use 100 % bonus depreciation for any component with a useful life of less than twenty years. That cost segregation study that we went through allowed us to allocate value to components with a useful life of five, seven fifteen and twenty seven and a half years.
The nice thing about bonus depreciation is that the value that we allocated to the five seven and fifteen year property can be 100 % expensed in the first year. Assuming that we do the cost segregation study in the first year of ownership, this bonus depreciation will result in writing off about 20 to 30 percent of the purchase price of your real estate in the first year. Even if it is not done in the first year of ownership, as long as the property was purchased after September of 2017, we can go back and get the benefit for past years without amending tax returns. This can result in large passive losses that you may be able to claim on your personal tax returns.
3. Passive Vs Active Losses
The third tip is that the amount of passive losses that you can take on your personal tax returns depends on several things:
If You Qualify As an Active Real Estate Professional
If you qualify as an active real estate professional, your losses are not considered passive, and may be used to offset your total income. To qualify as an active Real Estate Professional, you must:
- provide more than one-half of his or her total personal services in real property trades or businesses in which he or she materially participates
- perform more than 750 hours of services during the tax year in real property trades or businesses, with contemporaneous time logs that detail the services rendered.
- materially participate in each rental property, unless the you make an election to treat all interests in rental real estate as a single rental real estate activity.
These rules are far more complicated than we can address here. Be very careful in determining your status as a real estate professional, and consult with your tax professional or someone well-versed in the qualification process.
If You Don’t Qualify as an Active Real Estate Professional
If you don’t qualify as an active real estate professional, your loss is considered passive. Under the passive activity rules you can deduct up to $25,000 in passive losses against your ordinary income (W-2 wages) if your modified adjusted gross income (MAGI) is $100,000 or less. This deduction phases out $1 for every $2 of MAGI above $100,000 until $150,000 when it is completely phased out. If you cannot utilize the passive losses due to the passive loss restrictions, you can carry the loss forward and utilized in future years.
4. You Don’t Have to Wonder If This Is Right For You
You can find out quickly and easily if a cost segregation study would benefit you and your properties specifically. Click here to get a FREE preliminary analysis of your property or properties. Please put my name, David Wiener, in the “How Did Yo Hear About Us” box. This FREE analysis will show you what an engineering-based (best method) cost segregation study, done by the premier provider in the United States, would cost and the estimated tax benefit you would realize. I’ll be happy to review the analysis with you, as well as answer your questions about the Real Estate Professional designation and your situation.
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