Real Estate Depreciation Planning

We want to take this opportunity to describe a very important tax break approved by the IRS for owners of residential rental property and other types of buildings purchased or constructed after 2013. This tax break is called “cost redeprsegregation.” The tax savings can be very substantial and realized immediately.

Most owners of residential rental property depreciate the entire cost of their building over 27.5 years. Owners of other types of buildings acquired in 2014 or later, such as offices, retail space, grocery stores, restaurants, warehouses, and manufacturing plants often depreciate the entire cost using a 39-year depreciation period. Under IRS cost segregation guidelines, however, a portion of a building’s cost can be depreciated over much shorter periods, usually five or seven years.

The cost segregation rules are complicated, but in brief, they allow a taxpayer to separately depreciate components of a building that are unrelated to its “operation and maintenance” over the shortened depreciation periods. In addition, these depreciation deductions are computed using an accelerated depreciation method (the “200 percent declining balance method”) which allows costs to be recovered at twice the rate that applies under the “straight-line” method. The slower straight-line method is used to depreciate residential rental property and other types of buildings.

Many types of building components can qualify for the shortened depreciation period and accelerated depreciation method. It would be impossible to list them all, but common examples include molding, millwork, and other decorative elements, carpeting, wall coverings, partitions, window treatments, counters, cabinets, shelving, decorative accent lighting, specialized machinery and equipment (such as kitchen equipment), emergency generators, security systems, movable walls/partitions, music systems, window air conditioning units and the costs of plumbing and electrical components allocable to such equipment. In addition, certain land improvements located outside of a building may be depreciated over 15 years. Land improvements include items such as landscaping, fences, sidewalks, curbs, parking lots, lighting, utilities, signs, swimming pools, tennis courts, and playgrounds. Depending upon the type of building, you may expect to deduct between 10 and 60 percent of its cost over the shorter recovery period.

If you would like more information on cost segregation or if you feel you may benefit from a cost segregation analysis, please contact our office at your earliest convenience so that we may discuss this in greater detail.

Mike Trank – is a Tax Principal at Wertz & Company, LLP, a Professional Services Firm located in Orange County, CA that specializes in working with entrepreneurs along their journey to success.