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 Multifamily apartment investors can reduce their income tax liability and thereby increase returns in two ways—by directly purchasing rental properties or by passively investing in real estate syndications. If they choose the latter, they can conduct a cost segregation study with the help of a syndicator to maximize and accelerate depreciation.

Cost segregation is a tax planning strategy that has the potential to hold taxable income by depreciating certain aspects of a property at an increased speed. Depreciation refers to how much real estate decreases in value over time.

To understand how it works, it is crucial to know how depreciation expenses are calculated.

Understanding Cost Segregation

Without cost segregation, The IRS allows multifamily properties to have a depreciation period of 27.5 years using the straight-line methodology. This method calculates the depreciation expense by dividing the real estate’s cost basis by the property’s useful life, which is 27.5 years for multifamily assets.

For instance, if an apartment complex is worth $1 million, it can be divided by 27.5, resulting in $36,363 in allowable depreciation deduction each year. Now, with cost segregation, a physical inspection of a property will be conducted, and its components will be classified into different categories for which depreciation can be accelerated. The cost segregation studies are typically done by engineering firms.

For example, personal properties like bathroom fixtures can be depreciated over 5 to 7 years. Land improvements such as sidewalks and fencing can be depreciated over 15 years. It’s crucial to note that the value of the land is not included when calculating depreciation deductions.

By distributing a property into different categories and depreciating them over a shorter period, multifamily asset investors can experience the full benefits of depreciation. More importantly, the resulting tax liability is significantly decreased.

How the Tax Cuts and Jobs Act of 2017 Impacted Cost Segregation

Beginning 2001, real estate owners were permitted to take a depreciation deduction for a certain percentage of an eligible asset the year it was acquired. This was known as a “depreciation bonus.” It enabled taxpayers to take around a 50% depreciation deduction on their property in the year it was acquired. Also, it was limited to new assets with shorter than 20-year lifespans.

However, following the implementation of the Tax Cut and Jobs Acts (TCJA) of 2017, the 50% amount was increased to 100%, and the benefits were extended to older or used properties. It’s important to note that the TCJA is exclusive to assets purchased after September 27, 2017.

Get the Most Out of Your Investment

Cost segregation can result in up to hundreds of thousands of dollars in tax savings, depending on the type of property, especially with the TCJA’s 100% bonus depreciation. If you want to leverage cost segregation for tax purposes, partner with qualified professionals from Plus One Syndication

Plus One Syndication is an apartment investment and management group that helps clients identify the best real estate opportunities. You can rely on our team to perform rigorous property assessments and real estate market research to ensure that you get the most out of your investment.

Contact our Seattle office today at 206-278-4500 to learn more about our services.

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