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A cost segregation study is a tax strategy that can help real estate investors save on taxes for multifamily properties by accelerating depreciation deductions. Depreciation is a tax benefit that allows you to deduct the cost of a property over a specified period, typically 27.5 years for residential rental properties. However, cost segregation allows you to reclassify certain components of the property to shorter depreciation periods, such as 5, 7, or 15 years. In this post, we’ll cover the steps that syndicators take in order to save their investors thousands in taxes. We employ this strategy at JP Acquisitions and as you might expect have received overwhelming support to continue utilizing cost segregation studies. That being said, let’s jump in.
1. Hiring a Qualified Specialist and Conducting the Inspection: The first step in the process starts by hiring a qualified cost segregation firm with experience in real estate and tax law. They will conduct the study, which involves analyzing the property’s construction and components to determine which assets can be reclassified for accelerated depreciation. I’ll note that the process of analyzing the property requires either a professional from the firm’s team to come out and inspect the property in person or virtually through video chat. Either way works fine and it’s simply logistics that will determine if the inspection is in-person or virtual.
The specialist will conduct a thorough inspection of the property and gather detailed documentation, including blueprints, construction records, and financial statements. This information is essential for accurately identifying depreciable assets.
2. Asset Classification and Preparing the Report: The specialist will classify assets into different categories, such as structural components (27.5-year depreciation), personal property (5, 7, or 15-year depreciation), and land improvements (15-year depreciation). Personal property items might include carpeting, appliances, lighting fixtures, and more. The cost segregation specialist will then prepare a detailed report that outlines the reclassification of assets and their corresponding depreciation schedules. This report is crucial for substantiating your tax deductions in case of an IRS audit.
3. Benefit from Increased Cash Flow: Accelerated depreciation deductions result in higher depreciation expense, which reduces your taxable income. This, in turn, can lead to increased cash flow for your multifamily property as you pay less in taxes. The depreciation will be shown on your K-1 tax form to which you will hand over to your personal accountant. Going forward, you can continue to benefit from the accelerated depreciation deductions for the reclassified assets, which can offset rental income and reduce your tax liability.
Conclusion
It’s important to note that while cost segregation can provide immediate tax savings, it doesn’t eliminate your tax liability altogether. However, it can help you defer taxes and improve your property’s cash flow, which can be reinvested into your real estate portfolio or used for property improvements. Additionally, in order to write off any an not only passive income, you must be what is known as a “real estate professional” in the eyes of the IRS. In other words, to be a real estate professional you be able to meet the following requirements:
- Have more than half of the personal services you performed in all trades or businesses during the tax year in real property trades or businesses in which the you (i.e., the taxpayer) materially participated
- Perform more than 750 hours of services during the tax year in real property trades or businesses in which you materially participated (Sec. 469(c)(7)(B)).
Consult with a tax professional or CPA who specializes in real estate to ensure that cost segregation is a suitable strategy for your specific multifamily property and to navigate any IRS guidelines or regulations such as those stated above that may apply. If you happen to need a referral to either an accountant or cost segregation company, don’t hesitate to reach out to a member of our team!
If you have any questions regarding the terms and concepts in this post or previous ones, please reach out to either me (tedi.nati@jpacq.com) or someone on our team so we can help explain further. If you’re interested in investing with us at JP Acquisitions, you can contact us via email (contact@jpacq.com), LinkedIn, Instagram, or our investor portal to set up a meeting.
As always, I hope you enjoyed reading this post as much as I have writing it. Best of luck!
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About the Author
Tedi Nati is the Managing Partner of JP Acquisitions. In his role he is responsible for broker outreach, establishing deal flow, underwriting, marketing, and assisting in the closing process. In addition to his role at JP Acquisitions, he is an Assistant Equity Underwriter at Cinnaire, a non-profit Community Development Financial Institution (CFDI). In his role at Cinnaire, he is responsible for assisting the underwriting team in evaluating and structuring real estate equity investments and assessing the risks and mitigants associated with such. Tedi earned his Bachelor of Science in Finance from DePaul University, where he graduated Summa Cum Laude. In his free time he enjoys reading, looking for multifamily deals, and working out.
Make sure to always do your own research before making any final decisions on buying/investing real estate, stocks, or other securities. I am not a CPA, attorney, insurance, or financial adviser and the information in this blog post shall not be construed as tax, legal, insurance, construction, engineering, health and safety, electrical or financial advice. If stocks or companies are mentioned, I sometimes have an ownership interest in them – DO NOT make buying or selling decisions based on my posts alone. If you need such advice, please contact a qualified CPA, attorney, insurance agent, contractor/electrician/engineer/etc. or financial adviser.
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