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Understanding Depreciation and Cost Segregation

 

28 March 2024: Depreciation for rental property spreads the cost of the property across a predetermined length of time, as identified in the Internal Revenue Code (IRC). For residential rental properties, this duration is 27.5 years, per IRC Section 168(c), while commercial properties are depreciated over 39 years. 

 

The above approach is known as the straight-line method, which divides the property’s cost equally across each year of the applicable depreciation period. However, this uniform method may not be the most advantageous from a tax perspective. 

 

A more sophisticated tax strategy is available through cost segregation. Recognized by the Internal Revenue Service (IRS), cost segregation serves to accelerate depreciation deductions by separating property components by their respective class lives. 

 

Cost segregation involves an in-depth analysis that categorizes building elements apart from the building structure. These elements include tangible personal property like electrical systems and fixtures, non-structural elements such as carpeting, and land improvements like landscaping. 

 

According to IRC Sections 1245 and 1250, these components can be reclassified to a much shorter depreciable life — typically 5, 7, or 15 years — rather than adhering to the longer 27.5- or 39-year life of the entire building. 

 

By accelerating the depreciation schedule for these specific elements, the property owner can take larger upfront depreciation deductions. Such acceleration is permitted under the MACRS (Modified Accelerated Cost Recovery System) as outlined in IRC Section 168. 

 

This tactic can lead to substantial immediate tax savings, enhance cash flow, and optimize the financial performance of the investment property. 

 

For additional information, contact David Selig at (212) 974-3435

 

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