Anyone Use Cost Segregation Depreciation?
Normally depreciation for RE is 27.5 years for the value of the structures.
With Cost Segregation you can go even further and depreciate parts of your property more aggressivly (Driveways, roofs, appliances, carpets, etc.).
Does anyone have experience with this (good or bad)?
How many units would you have to have before it would be worth the hassle and cost?
Would you recommend it?
Obviously your taxes will be higher as you deplete the depreciation in various segregated parts, but it would give you greater cash flow up front it seems. As long as you sell it on a 1031 it seems like it would be a good thing to do. Your thoughts???
This is sometimes called component depreciation. I don't do it with a new acquisition, because of the time and effort to allocate my purchase price among all the depreciable components of the property. I do depreciate a new component when it is replaced.
Component depreciation is recommended by tax gurus such as Diane Kennedy, John Hyre, and Al Aiello. The theory being that you increase your depreciation expense to offset more current rental income for items that have a useful life less than 27.5 years.
Cost segregation probably works best for properties costing $1,000,000 or more. (Tho it seems similar to component depreciation, cost segregation has a different theory and thinking. Component depreciation per se was outlawed by the 1981 or 1987 tax act.)
I have used it (informally) on some of my client's properties; but the larger the project (and the sooner you get into the project) the more you save.
There may be other tax costs of the cost segregation. For instance, in SC any costs reallocated to personal property should be reported on the personal property tax return, but will probably NOT reduce the real estate property tax. Also, when the property is sold, you will need to allocate the sales price over the assets sold and you may have ordinary income recapture.
All the same, I think that cost segregation is almost always worthwhile to do.
Component depreciation is not allowed under the standard, no questions asked Modified Asset Cost Recovery System (MACRS) created by our lawmakers. The U.S. Tax Court has ruled, however, that some elements of a building may be separately depreciated as personal property even under MACRS.
The Internal Revenue Service recently agreed to go along with the Tax Court's ruling that the former investment tax credit rules apply in determining whether an item is a structural component or personal property. The IRS did not, however, go along with the Tax Court's complete finding about what was personal property under the rules.
Under our basic tax rules, the cost of most buildings -- commercial property, or nonresidential real property as they are labeled in the tax laws -- placed in service today, must be recovered over a period of 39 years.
In the case Hospital Corp. of America v. Commissioner, 109 T.C. 21 (1997), the Tax Court considered whether various items in the taxpayer's building were structural components of the building or whether they were Section 1245 property qualifying for a much shorter recovery period. According to the Tax Court, "an item constitutes a structural component of a building if the item relates to the operation and maintenance of the building."
Among the items that were found to be Section 1245 property were: electrical distribution systems, television wiring, telephone equipment, carpeting, vinyl wall and floor coverings, kitchen plumbing connections and exhaust hoods, patient corridor handrails and accordion-style room dividers. According to the court, these items either related to HCA's business of furnishing medical services, did not relate to the operation or maintenance of HCA's buildings and were not intended to be permanent.
What's more these assets, as Section 1245 property qualified for a fast five-year recovery period. That five-year recovery period also makes them eligible for the "bonus" depreciation under the new tax laws.