As I discussed in my “Common Real Estate Tax Benefits” video, one of the key qualities that make real estate investments stand out from other types of investments is the ability to depreciate the actual property — among other deductions. The rule is that if you own an apartment or multifamily building, you can write off the improvements in a straight line method over 27 in a half years. If you own any other type of asset such as an office or warehouse that is then written off over 39 years. Remember, you can ONLY depreciate the building, not the land. The tax code basically says that land never uses its value.
There is a way however, to potentially write off portions of your building FASTER than the 27 in a half or 39 year time frame. It’s a process called cost segregation, or Accelerated Depreciation. The concept is that even though the building may last for 27 in a half or 39 years, what about the windows? The doors, the carpets, roof…bathrooms even? What about all the little parts that make up a building? Are those expected to last over two decades?? Absolutely not. This is why all savvy investors should seriously consider conducting an accelerated depreciation study. Let’s run through an example to show you the benefits.
Let’s say you purchased a retail building for $2M. And for the sake of making numbers easy, 50% of that value is allotted to the land, and the other half allotted to the improvements. This means you can write off $1M over 39 years. By doing so, you can write off $25,640/year in your taxes — with the exception of your first and last year of ownership. But again, what about the roof, the signage or anything else that exists in the building?? As the building owner, you then hire a person or a group to come out and do a study. For a fee which will likely cost a few thousand dollars, they determine that certain parts of your building can be written off more quickly. Windows, the roof and everything else, have a tax depreciation schedule of 3, 5, 7 years or whatever it may be. And in fact, they determine the estimate replacement cost of those items.
Now, it’s been determined that you can write off $50,000/year for 5 years, then $35k for 2 more years, and $20k after that! Of course, this is a made up scenario, but the numbers aren’t farfetched — they are completely plausible. In our scenario, over a 7 year timeframe you will have saved an ADDITIONAL $140k, or about $20,000 per year. Depending on your tax base, the fee you paid the individual or group has easily paid for itself within a year or two.
If you’re wondering if getting an accelerated depreciation study is right for you, here are a few tips I always tell people. First, don’t use someone who isn’t a professional. Although this is a legitimate tax strategy, whoever does the study MUST have paperwork to back their claims in case you ever get audited. Also, if you own a smaller building which cost under $300-400k, it starts to not be a profitable course. Simply because the value of the taxes saved won’t pay for the cost of the study in a meaningful timeframe. However, if you own anything larger and are interested in saving some money, it would likely be in your best interest to contact the proper professional or group and see if it’s worth it. Most of the time the appraisers will let you know after conducting a calculating a quick assessment if the study is even worth pursuing…for free….now that’s good to know. 🙂
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