A cost segregation study is something that can help you maximize the depreciation you claim on your taxes for the St. Louis investment property that you rent out to residents. When it comes to tax filings, the property owners and real estate investors we work with know that they can generally depreciate residential rental property over 27.5 years. Commercial real estate investors depreciate over a period of 39 years for tax purposes.
What’s often overlooked on these tax deductions is that we’re not just depreciating the building as a structure. It’s not possible to depreciate land; the IRS doesn’t allow that. However, a rental home includes more than the walls and floors; there are also plumbing fixtures, carpets, and other assets that are included in the property. If you bought them on their own, separate from the rental property you own, you could depreciate them over five, seven, or even 15 years. But when they come with your property, they’re written off as part of the building, and the useful life is the incorporated 27.5 or 39 years.
This is where a cost segregation study can help. It provides a process to look at each element of a property. The study will split each asset into different categories, allowing you to potentially benefit from an accelerated depreciation timeline. There’s a cost to commissioning the study from a team of tax and engineering experts, but the tax savings from accelerating depreciation deductions can result in significantly increased cash flow over several years.
How Cost Segregation Studies Work and Why They Matter
The goal of a cost segregation study is to separate and identify all property-related costs that can be depreciated on your taxes. These depreciation schedules may be for periods of five, seven, or 15 years. They might also be written off faster using bonus depreciation, which is 80% through 2023. That bonus depreciation will drop to 60% for 2024, 40% for 2025, 20% for 2026, and 0% beginning in 2027. Prepare for this with your tax advisor and your St. Louis property manager.
To make sure you’re maximizing every benefit you can when it comes to taxes and your investment property, the cost segregation study will have your advisory team reviewing available property records, inspection reports, cost details, and blueprints. You can also expect the team to conduct a physical inspection of the property.
Segregating the costs of your investment property will matter when you’re measuring the financial benefits it provides against the cost and the time it takes to complete such a study. If you have the potential to save more in taxes, you should take the opportunity to leverage those savings.
With a cost segregation study, you can save more money over the long term. This makes the most sense for real estate investors who plan to hold their St. Louis rental properties for the long term. Whether they’re residential homes or commercial buildings, you’ll benefit most from the cost segregation analysis when your investment strategy is to buy and hold. If you don’t plan on holding the property for the long term, you may not get any benefit from having a cost segregation study because any up-front benefits reverse upon the sale of the property.
We recommend that if investors are going to conduct a cost segregation study, they plan for it even before they purchase an investment property. You’ll get the most from this study if you have it performed in the year the building is acquired, constructed, or remodeled.
There’s also the option of a look-back study, which can be done any time afterwards. You’ll be able to claim the resulting write-offs without amending your tax returns that were filed in prior years.
Step-by-Step Look at Cost Segregation Studies
The key to making a cost segregation study work is to be prepared for what you’re required to do. First, you’ll have to schedule a cost segregation study. Talk to your St. Louis property management partner if you’re not sure where to find a reliable financial firm. You’re looking for professionals who have experience in fields such as engineering, construction, tax law, and accounting.
- Feasibility Analysis
First, your cost segregation team will conduct a feasibility analysis. This is done to analyze your property and its features to ensure it’s a good candidate for cost segregation. You can expect that the segregation team will evaluate and study the different components of your investment property. In residential rental homes, this is typically:
- Plumbing fixtures
- Roofing age and materials
- Electrical systems
Here’s why it matters: if you bought these items separately, you would be allowed under the IRS tax code to depreciate them over 5 to 15 years. But, if you have these items included in a building or a home that you purchased, you are only allowed to depreciate them over 27.5 years (residential) or 39 (commercial).
During your cost segregation study, your team of engineering and financial experts will separate each part of your investment property and place them in their own categories. This might lead to an accelerated depreciation timeline for some of those building features.
- Providing Necessary Documents
The team of experts performing your property’s cost segregation study will need several specific items and documents to determine the value of your building and its systems. Before the study begins, make sure you have as much available as possible. Gather any recent appraisals of the property or inspection reports. Maintenance records can help, and you’ll need the closing documents you signed when buying your investment property.
- Property Analysis
As we said earlier, a property inspection is often required before the study is complete.
Your team members will identify any operating costs of your investment property that you can depreciate over either 5, 7 or 15 years. This will depend on the documents you provide as well as blueprints, property records, and inspection reports.
Finally, you get a detailed report that you can use to determine how much you can save on your income taxes by using cost segregation strategies.
As your St. Louis property management partner, we’d be happy to talk more with you about the benefits of cost segregation studies. Contact us at Deca Property Management.