Cost segregation is a tax-saving strategy that allows real estate investors to accelerate depreciation on their properties. While it can be highly effective for the right individuals, understanding when and how to implement this strategy is essential for maximizing its benefits.
Who Benefits from Cost Segregation?
Cost segregation is most commonly utilized by real estate investors who meet one or more of the following criteria:
- Annual Income Below $150,000: Investors below this threshold can take advantage of the losses real estate brings, up to $25,000 in losses can be used to offset other income depending on income. There is a phase-out income limit that reduces the $25,000
- Owners of Short-Term Rentals: If you own short-term rental properties, cost segregation can unlock substantial tax savings.
- Real Estate Professionals: Those who qualify for real estate professional status often gain the most from cost segregation, as they can deduct real estate losses in excess of $25,000. This is powerful when one spouse in a real estate professional and the other has a large W-2 salary or business.
If you don’t fall into one of these categories, cost segregation might not be the best fit for your investment strategy.
When is the Right Time to Do a Cost Segregation Study?
The timing of a cost segregation study depends on several factors, including property value, land value, and bonus depreciation regulations.
- Property Value Threshold:
- We typically recommend cost segregation when the building value (not total property value) is at least $200,000. This ensures the potential tax savings outweigh the cost of conducting the study.
- Bonus Depreciation Considerations:
- As of 2024, bonus depreciation is 60%, which impacts the overall benefit of cost segregation. If bonus depreciation percentages rise in the future, it may make sense to consider cost segregation for properties with lower building values.
When Can a Cost Segregation Be Conducted?
Cost segregation studies can technically be performed at any time, but their timing affects tax returns differently:
- Current Year Tax Returns:
- To impact the current year’s tax return, the cost segregation study must be completed and included before the tax return is filed.
- Example: If you purchase a property on December 31, 2024, and decide in early 2025 to conduct a cost segregation, you can still apply it to your 2024 tax return—as long as the return hasn’t been filed yet.
- Future Years:
- For prior-year properties, cost segregation can be applied retroactively by filing Form 3115 (Change in Accounting Method). This allows you to adjust depreciation and claim missed benefits in subsequent tax returns.
Important Considerations
Cost segregation is not a universal solution. It’s essential to evaluate individual circumstances, including building value, land value, and bonus depreciation. Additionally, different cost segregation options are available, each tailored to specific scenarios—a topic we’ll explore in a future post.
Conclusion
Cost segregation can be a powerful tool for tax savings, but timing and context are everything. If you’re considering this strategy, ensure your property meets the right criteria and consult a tax professional to assess its potential impact on your financial situation.
At Thompson Tax Group LLC, we specialize in helping clients navigate the complexities of cost segregation. Contact us to determine whether this approach aligns with your investment goals.
.png){kind=link}