As a real estate agent, I’m often asked by landlords and potential rental investors about the purpose and benefit of a cost segregation study.
My response is always that you should obtain professional financial advice before making any decisions as a property investor. This includes every time you decide to expand your portfolio.
Cost segregation studies are not suitable for every property investor. Mostly, they’re commissioned by owners of commercial property or landlords who have built a portfolio of residential rental accommodation.
Usually, a study is conducted either immediately after a property is purchased or within 12 months to ensure it provides the landlord with the maximum financial benefit. The aim is to use the accelerated schedules to reduce your income tax rate.
They are highly technical and not cheap. It should always be undertaken on your behalf by a professional. The costs can vary, but you should expect to pay a minimum of $10,000. The good news here is that the fee should be tax-deductible.
The purpose of the study is to accelerate your depreciation schedule. Without a study, it would take almost 28 years to depreciate the cost of a rental property. With a study, you can segment elements of the property so they can be depreciated over five, seven, 15 and the maximum 27.5 years.
Among the items that can be included in the study are carpets, overhead lighting fixtures, vinyl wall and floor coverings, kitchen equipment such as an exhaust fan, air-conditioning and concrete slab flooring.
Claiming against a single property might not deliver a big payback as there’s insufficient property to include in the schedule to justify the expense of establishing a schedule.
If you had five properties in your portfolio, you’d receive five times the benefit, and this might make the process viable.
There are some tricky elements to a study. Firstly, you need to be able to distinguish between items that are “personal” and those integral to the property. Secondly, you need to be able to ascertain fair market value for each item being claimed.
The IRS has been known to come down on landlords that are too aggressive in their claims. This is another good reason to seek professional financial advice.