Taxpayers who qualify as real estate professionals face fewer restrictions on how they can apply deductions generated by their properties. If a cost segregation study generates $100,000 of depreciation expenses, then the taxpayer is free to use those deductions to offset other sources of income. Therefore, cost segregation has a clear benefit for real estate professionals who can use extra deductions as they please.

For other taxpayers, the IRS limits how real estate deductions such as depreciation can be used. In general, depreciation expenses from a building can only be used to offset income generated by that building. 

Nevertheless, cost segregation can still be appealing for taxpayers who do not qualify as real estate professionals. Depreciation from a rental property can be used to offset that property’s rental income. If depreciation expenses exceed income, then the expenses are carried forward into the next tax year.

This post will explore in further detail the impact of cost segregation for taxpayers who do not qualify as real estate professionals.

Example Scenario: Cost Segregation on a Residential Rental

To clarify the impact of real estate professional status, let’s take a look at an example. We will look at the impact of cost segregation on a $350,000 residential rental property–such as a duplex or fourplex–and how the additional deductions would affect both a real estate professional and a regular taxpayer. Either way, we will assume that our taxpayer has an income that places him in the highest tax bracket, meaning that he will be subject to a 37% marginal tax rate.

We can see in the above illustration that the regular taxpayer still receives a significant benefit from cost segregation. IRS rules prevent him from taking the deductions all at once, but by year three of ownership, he will have received $26,000 of tax savings. This is the same savings that the real estate professional would receive in the first year.

When to Consider Cost Segregation on Your Rental Property

As we see in the illustration above, cost segregation is beneficial for regular taxpayers. However, one major assumption we made is that the rental property is generating a substantial income. In cases where the income from the property is low or where there are already significant deductions, the impact of the additional deductions generated from cost segregation could be reduced.

We can provide an estimate of your tax savings at no cost. Use our Request a PA form or contact our office at (225) 291-0046 to see what your tax savings could be.

For more information please contact our Director of Cost Segregation at clayton@lumpkinagency.com.

The information provided in this blog is intended for general information only, and is not meant to constitute tax advice.