CPAs - do you have real estate investor (REI) clients? If so, here's why you need to know about cost segregation. Not only could they benefit from saving money on their taxes, but they will thank you for providing extra value as their CPA and better yet, it's increased revenue for your firm. Win-win-win!
What is Cost Segregation?
Cost segregation is an advanced tax planning strategy (IRS approved) designed for REIs to reduce their current tax liability, thus resulting in more cash in their pockets.
To elaborate, cost segregation works by depreciating qualified assets in a property, such as carpeting, certain plumbing fixtures, specialty lighting and even landscaping. With cost segregation, qualified assets can be depreciated much quicker (either 5, 7 or 15 years, to be exact). Without cost segregation these assets are depreciated over 39 years (commercial) or 27.5 years (residential).
Now, it’s obvious that carpet doesn’t last for 27.5 years, so why let it depreciate over that long of a time frame?
It is important to note that the depreciation captured from cost segregation is considered a passive loss and can only be used to offset passive income. Therefore, cost segregation is especially beneficial for wealthier investors with significant passive income or those who qualify as designated Real Estate Professional.
Cost Segregation Misconceptions
If you have heard or are familiar with cost segregation, there are a few misconceptions I would like to clear up. Speaking with CPAs and accounting professionals, I have heard my fair share of these misunderstandings. I get it though! It’s a complicated tax strategy.
One of the biggest misconceptions is that cost segregation can only be done on buildings with a basis of over $1,000,000, this is far from wrong as I have seen plenty of REIs executing a cost segregation study on their single family residential rentals. But the fun doesn’t stop there, cost segregation can be done on virtually any building. From single family residences to shopping centers, the opportunities are quite endless!
Another misconception I hear is that cost segregation can only be done during the first year of purchase. Well, fortunately, this is not true. Cost segregation can be done anytime during ownership. It’s called “catch-up” depreciation. Basically it’s playing “catch-up” by accelerating the depreciation that would have otherwise been captured during the first year of ownership.
So what’s the catch? The Form 3115 (Change in Accounting Method), must be filed. Sure the form is tricky, but well worth it, if you can catch up your client’s depreciation. I am sure they will thank you!
How Cost Segregation Benefits Accounting Professionals
Whether you’re a partner in a firm or a staff accountant, at the end of the day, you want to see your place of employment prosper and grow. By introducing an additional service, like cost segregation, it’s just another way to do exactly that.
Besides reducing your client’s tax liability, cost segregation is beneficial all year round, as it doesn’t have to be done just during tax season. In fact, the most strategic and efficient CPAs do cost segregation during the summer months for not only the additional revenue stream it can produce, but for the fact that the workload isn’t as hectic during the “slow” months.
At the end of the day, understanding how cost segregation could potentially help your REI clients is an added bonus in providing value and revenue for both parties. Just keep in mind that, according to the IRS Cost Segregation Audit Techniques Guide, “cost segregation studies requires knowledge of both the construction process and the tax law involving property classifications for depreciation purposes.”