Depreciation schedules. IRS codes. Accounting. Paperwork.
The very thought of these concepts is enough to put me to sleep at my desk.
…or at least it used to be.
Then I learned the power unleashed in the simple but powerful strategy of accelerated depreciation. And when I was evaluating a change in career focus to dive into multifamily investing, it was one of the reasons I actually took the plunge. Well, I didn’t change for the IRS codes and schedules and such. I did it for the surprising power unlocked in this concept. I will never view taxes the same!
In a previous article, I talked about the many tax-saving opportunities a multifamily investor can achieve by hiring the right counsel. Specifically, I encouraged investors to retain a tax strategist to help them legitimately minimize taxes.
Though many of the concepts were familiar, perhaps one of the least familiar was accelerating depreciation through a cost segregation study.
This often allows commercial property owners to offset most or all of their income from an asset through faster-than-standard depreciation. As a result, owner/investors get distribution checks in the mail all year long—then a negative number on their K-1 at year-end.
It’s hard to beat that. And this benefit typically goes on for quite a few years.
This is another reason I specifically chose commercial (large scale) multifamily investing over single family or smaller scale multifamily investing. Before we get into the details of cost segregation, let’s back up and review the basis for this powerful tax-avoidance strategy.
Depreciation is a method for allocating the cost of a tangible asset over its useful life. Since the IRS would not allow a million-dollar tax deduction in the year of that million-dollar purchase, the million dollars is allocated via formula over the projected useful life of that asset. This provides a deduction to the income for the owner in each year the asset is depreciated.
For example, if a machine is purchased for a million dollars and its useful life is 10 years, it would (typically—if straight line) be depreciated at $100,000 annually.
If a million-dollar building that houses that machine will be usable for decades, it might be depreciated over 39 years. (Typical IRS categories for permanent structures include 27.5 years and 39 years, but there are others.) Land is not depreciable since its value does not typically drop with use over time.
If you’re having trouble sleeping, you can check out the IRS depreciation code for yourself by clicking here.
As a direct, fractional owner of commercial real estate, you get a direct benefit from the financial depreciation of the asset. This means your income will be reduced by the amount of the asset’s depreciation that year. Your CPA undoubtedly knows this. You probably yawned as you skimmed through it.
But you may not have been aware—and some accountants may not have told you—that there is a way to dramatically accelerate your income deductions and tax savings using componentized depreciation a.k.a. cost segregation.
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