BLOODHOUNDBLOG.COM

There’s always something to howl about

Archive for February, 2007

Understanding Why Depreciation Isn’t Just An Add-on — Cost Segregation

What is cost segregation? In a nutshell it’s the process by which an investor can increase the amount of total depreciation taken on each investment property. It will deal almost exclusively with the personal property which is part of the real estate. These personal property assets include a building’s non-structural elements, exterior land improvements and indirect construction costs. This is usually the point at which investors begin to glaze over.

Not so fast write-off breath.

Once you fully understand the results of successful cost segregation, you’ll be a fan for life. The difference between what the average investor claims for depreciation and what’s actually available is staggering to most when they see it for the first time. If you want to try it out on your own, go here. I strongly recommend though, that you hire a firm specializing in this process, as the IRS much prefers that approach.

What’s the average? In my experience and in talking with various CPA’s over the years, the average taxpayer claims the normal building depreciation using the schedules requiring a 27.5 or 39 year life. Many will then add a few personal assets to the mix, but not nearly what is available to them.

Take a $500K purchase of residential income property.

Let’s say it was built a couple years ago, and you can support a land value of $100K. This results in the building being depreciated at $14,500 a year. Investors then will add a few items of personal property, depreciated over five years. Let’s say the average runs around $5.5K. They now have $20K in depreciation. At the blended tax rate of 33% state/fed, this results in a tax savings of just under $6,700.

However, if this investor takes advantage of cost segregation, his depreciation could increase dramatically. Typically, the engineers will literally look at every single part of your property. This includes but isn’t limited to driveways, landscaping, exterior stairs, HVAC systems, and on and on. It’s common for them to find roughly 6-20% of the purchase price, including land, in new depreciation. (They often find much more than that.) Using this example that would mean give or take $30K (6%) in additional tax shelter. Let’s forget the puny amount the investor was taking before. Let’s just add up what they found to the building’s figure of $14,500 a year.

Dollars

You now have almost $45K in annual depreciation which results in about $15K in tax savings. That’s huge. And if you bought these units with a low down hoping to break even, you now have an after tax positive cash flow to enjoy. If you put 10% down plus closing costs, the total cash needed to close this property was about $62K or so. You now have a cash on cash return (after tax) of 24%!

Oh sure, now you’re paying attention. :)

This past week I was talking with a cost segregation expert, based in San Diego. He gave me a recent example of an investor who paid his company $9K for an in depth study of a purchase he’d made a couple years earlier. They found an addtional $450K of depreciation! It’s fully documented for the IRS, and the company will defend the investor at no cost, without even asking for travel expenses. Using that client’s blended tax rate, which was 40%, the use of cost segregation found an additional after tax income of $15K A MONTH.

And you can go back in time to benefit from this. You’ll have to file a modification of accounting method with the IRS.

I’ll be talking more about this on my own blog. Pay attention to this opportunity. It’s allowed many of my clients to completely avoid the use of tax deferred exchanges.

Of course, that’s a whole different can of worms, isn’t it?

Related posts:

Fatal error: Call to undefined function related_posts() in /home/splend10/public_html/bloodhoundrealty.com/BloodhoundBlog/wp-content/themes/in3d-10/archive.php on line 60