Multifamily properties provide greater cash flow compared to single-family homes. However, investors will still have to shoulder a heavy tax burden if a multifamily property is fully occupied and produces a consistently healthy revenue stream.
One way to lessen these tax deductibles is to use cost segregation.
Cost segregation explained
When calculating the taxes on a multifamily asset, investors will have to consider the projects they have initiated to improve the property. Reparation and renovation activities, for one, are included in calculating for depreciation.
Then again, assessors would take note of a property’s depreciation over a 27.5-year period. In this sense, the property is assessed as a whole (or depreciated straight-line) without considering the individual parts – that is, lighting fixtures, sheds, plumbing fixtures, carpeting, among others. The accumulated depreciation is then calculated by dividing a building’s assessed value by 27.5. This leaves investors with a tax deduction based on a single asset.
When investors have given new life to several components of the property, these renovations should be taken as separate items that follow a 5, 7, or 15-year schedule instead of being taken as part of the building’s structure and thus follow the 27.5-year schedule.
Leveraging cost segregation
With a cost segregation study, we take into account the individual parts of the property and assess their usefulness within a much shorter period. Carpeting, for instance, is depreciated over five years. On the other hand, landscaping and other land improvements such as trees and hedges are depreciated over 15 years.
By adding components with a new life of 5 and 15 years and segregating them from the building itself, investors can accelerate a property’s depreciation even further, resulting in bigger tax deductions.
Indeed, cost segregation is a powerful strategy for reducing your tax liabilities. However, extra care is important when justifying your improvements and ensure that you follow IRS rules to avoid added penalties.
As always, please consult with your tax accountant to make sure what strategy works best for you.
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