What is Accelerated Depreciation/Cost Segregation?
In last week’s article, we briefly discussed depreciation and the tax benefit it provides for multifamily investors. One of the assumptions of straight depreciation is that every part of a property will degrade from full value to zero value over a period of 27.5 years. It should be evident from personal experience though that there are many components to a property that will deplete their useful life in far less time. Things such as flooring, appliances, parking lots, roofs and many other high value pieces of a property will need to be replaced on a much more consistent basis.
The IRS also recognizes this fact and therefore allows for accelerated depreciation of these items through cost segregation. Cost segregation is breaking a property down into all the components that it is made of and then assigning a depreciation schedule to each individual component based on its specification from the IRS. For example, flooring and HVAC can be depreciated over 5 years, cable and communication lines over 7 years and most exterior land improvements like sidewalks are depreciated over a 15-year period.
So, what does all this mean to the investor? In short, if you own a property for say 5 years, you will be able to deduct a tremendous amount of taxes during those five years due to the accelerated depreciation on many components of the property. However, there is even better news. Thanks for the 2017 tax act, investors are eligible to take “Bonus Depreciation” which allows all items with a depreciation schedule of 15 years or less to be deducted in the first year owning the property! This is an enormous benefit that has driven most investors to perform a cost segregation study to take advantage of this tax law. While we do not know how long this law will be in place, cost segregation at its base level will likely continue to be a strong tax benefit for the multifamily real estate investor well into the future.
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