How to use cost segregation studies for tax savings on a new multifamily asset

November 16, 2022 | Buyers

Learn how to get a refund from the IRS of over 50% of your down payment for the purchase of your next apartment building

Cost segregation studies offer vast opportunities to multifamily buyers, and there’s no better time to utilize them than before December 31, 2022 when Section 179 of the tax codes still allows for 100% bonus depreciation. 

If you’re ready to purchase a property or if you purchased a property in the last few years, continue reading for pro tips on how to get the majority of your down payment on an apartment building you just bought back in tax savings through a cost segregation study with first hand insights from Joe LaFleur, our founder and multifamily investment advisor.

What is a cost segregation study? 

As an IRS-approved tax cost planning strategy, cost segregation studies allow you to depreciate quicker on the personal property portion of recently purchased real estate assets to get immediate tax benefits. 

Related resources:
What are the benefits of cost segregation for multifamily properties?

How does a cost segregation study work? 

If you purchase a multifamily building, the typical requirement is straight line depreciation over 27.5 years. With a cost segregation study, you break apart your newly purchased apartment building into all of its individual parts, including the ones that are personal properties or provide shorter depreciations, and move them all forward with Section 179 of the tax codes which allows you to take bonus depreciation in the year your property is purchased.

For example, a cost segregation study begins by looking at all the depreciable assets in a building. The foundation, walls, roof, and structure of the building will all still depreciate over 27.5 years. The bonus depreciation of the cost segregation study comes in through all of the other components—air conditioners, toilets, water heaters, countertops, appliances, flooring, light fixtures—that are all depreciable over shorter amounts of time. Thanks to Section 179 bonus depreciation, they can be pulled forward into the year the building was purchased.

Cost segregation studies offer vast opportunities to multifamily buyers

How does real estate professional status tie into a cost segregation study? 

Once you understand the value of a cost segregation study, it’s important to determine if you or your spouse could file for real estate professional status and take your tax savings to the next level. 

If you are able to achieve IRS real estate professional status, you will have the ability to offset active income and passive losses. You would need to consult with a CPA for exact qualifications, but the main requirement to become certified is that you spend over half your time in the real estate business as a profession.

When you do a cost segregation study on a building with real estate professional status and you pull forward all of those depreciable assets into the same year of purchase, you will be given all that depreciation in that year.

If you file jointly as a couple, you may have one person who is a high income earner with tons of dividends from their business as active income, but the second spouse is not active in that business then they can qualify for real estate professional status from the IRS. It will allow you to write off the passive losses of that bonus depreciation against the active income to get the vast majority of your down payment on the building back in tax savings at the end of the year.

What’s the bottom line? 

“When you purchase a building, you’re typically putting in a 25-30% down payment. By using a cost segregation study to get 20-25% of the building in tax savings, you’re essentially taking the money that you would’ve just sent to the IRS as taxes and purchasing your next building,” says Joe. 

“If you’re interested in a cost segregation study, you should go talk to your CPA or tax attorney to provide you with the information you need,” explains Joe. “Many of the active buyers we are working with are successfully using this strategy, so check it out and make sure you’re talking to your tax professionals.”

How we can help with your cost segregation study

If you need some insights on who to use for a cost segregation study, check out the best in the business on our curated vendors list under ‘Cost Segregation’.

We hope you’ve found this resource valuable! If you’re ready to learn even more about multifamily investing, join us for our Monthly Virtual Summits featuring a wide variety of tips for buyers and sellers ready to level up their professional status. 

Upcoming topics include: 

  • Preparing your Property (December 15, 2022) 
  • Quarterly Multifamily Market Update (January 19, 2023)
  • Preparing your Property Financials (February 16, 2023) 

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