Rental property is typically depreciated using a straight line over 27.5 years.

It's better to separate property assets by class life and segment the deductions - this will accelerate depreciation deductions - and for most investors, money now is more valueable than money later.

Do investors typically do this?

If they don't, why do you think that is?

Is it a hassle? Does it cost too much? Do they simply not know? Are they afraid?

I'm curious to hear what people have to say....

Rental property is typically depreciated using a straight line over 27.5 years.

For residential property, yes. Commercial property gets 39 years.

It's better to separate property assets by class life and segment the deductions - this will accelerate depreciation deductions - and for most investors, money now is more valueable than money later.

OK.

Do investors typically do this?

Small investors? No. Big investors? Yes.

If they don't, why do you think that is?

The cost of the engineering study to appropriately segregate the costs is prohibitively expensive for a single family residence. It doesn't make sense to spend several thousand dollars on a study so that you can claim several hundred dollars a year more in depreciation.

Also, if your investing horizon is short - if you are a flipper - you don't have the necessary time for the accelerated depreciation deductions to work their magic. Remember that cost segregation is really just a timing issue. It's not going to change the overall amount of the depreciation. It just affects the timing of those depreciation deductions - by accelerating them.

So if you are only holding a property for a couple of years, the timing of depreciation isn't as important as it would be if you were holding the property for 15 or 20 years or more.

Is it a hassle?

A bit, just in the initial year. You've got to pay your accountant to set up all of those separate assets instead of just land a building. That costs a bit extra.

Does it cost too much?

Absolutely. My SWAG is that a property needs to cost at least a couple million dollars before a cost segregation study becomes worthwhile.

Do they simply not know?

Sometimes.

Are they afraid?

Sometimes. There are a number of folks who will take less aggressive tax positions because they prefer the peace of mind over the marginal tax savings.

I'm curious to hear what people have to say....

Well, you've got my thoughts now. That, and 3 bucks will get you a latte at Starbucks. ;-)

--Peter

PS - One more area you didn't mention. Having a cost-segregated property greatly increases the complexity of things if you ever want to do a like kind exchange. You've got to find a property that has all of the appropriate segregated costs so that you can exchange each kind of property in the old and new pieces of real estate. Otherwise, all of that accelerated depreciation will get recaptured and taxed in the exchange.

So once you get on the cost segregation train, it's expensive to get off. And it can be expensive - in professional fees - just to stay on it.

Thank you very much, you certainly know what you are talking about. I guess I should have been clearer in asking my question.

I understand that for a residential rental worth less than $1M, it is not worth the cost and hassle of a cost segregation study.

Say you have a SFH worth $500,000, and it's brand new, and you happen to know the costs of some of the assets within the home (carpet, stove, washer, dryer, refrigerator, fence, other 5 & 15 year assets etc...)

And assume you do your own taxes. Would you go through the trouble of separating them out and depreciating them separately? There are websites that are free and make it easy to do, I'm wondering why not everyone is using them.

You are completely right in your PS comment. Do you think the IRS comes down on those heavily for property worth less than $1M.

From my understanding of what you are saying, say property A has a $2k washer, and property B has a $1K washer. This is an issue since you are trading down - but what if property A had a $1k dryer and property B had a $3k dryer? Wouldn't the common assets just offset each other since they are like-kind.

This is a weird example, I was just trying to illustrate. I guess I am generally assuming that you will always be trading up in a 1031...

I'd love to hear your thoughts.

Say you have a SFH worth $500,000, and it's brand new, and you happen to know the costs of some of the assets within the home (carpet, stove, washer, dryer, refrigerator, fence, other 5 & 15 year assets etc...)

And assume you do your own taxes. Would you go through the trouble of separating them out and depreciating them separately? There are websites that are free and make it easy to do, I'm wondering why not everyone is using them.
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That's exactly what I do. These items are on a different depreciation schedule, and faster, so the tax benefits accrue in my favor early on. Plus, these thing actually do need to be replaced.

MZ4

Thank you very much, you certainly know what you are talking about.

Being a tax professional, I try to keep up with things. It helps keep the malpractice lawsuits at bay. ;-)

And now that tax season is finally over, I can wax philosophical again as necessary.

I guess I should have been clearer in asking my question.

OK.

I understand that for a residential rental worth less than $1M, it is not worth the cost and hassle of a cost segregation study.

I agree.

Say you have a SFH worth $500,000, and it's brand new, and you happen to know the costs of some of the assets within the home (carpet, stove, washer, dryer, refrigerator, fence, other 5 & 15 year assets etc...)

OK.

And assume you do your own taxes.

No need to assume that. I really DO do my own taxes. The only problem I have is getting that lousy client to give me some data to work with. ;-)

Would you go through the trouble of separating them out and depreciating them separately?

Me? Probably. Joe six-pack who rents out the house he inherited? Probably not.

There are websites that are free and make it easy to do, I'm wondering why not everyone is using them.

1. Contrary to popular belief on the internet, not everyone is internet savvy. I'd put it at well under half the population that is internet savvy. So those web sites don't help a whole lot of people. BTW, would you have a link to a couple of them? I'm sure folks here would be interested.

2. Simplicity. I mentioned that before. By segregating out assets, you are adding a significant degree of complexity. Many people fear complexity. And many people fear the IRS. Combine those two populations (and eliminate the overlap) and you've got a whole lot of people who prefer to just separate land and building and go from there.

3. Value. Back onto the SFR scenario, the total dollars involved by segregating out certain assets just aren't that big. Sometimes its just not worth the effort.

You are completely right in your PS comment. Do you think the IRS comes down on those heavily for property worth less than $1M.

No. If anything, I'd guess they come down more heavily on more expensive properties. Presumably, those are owned by more sophisticated owners, who are paying for more cutting edge advice and will take more aggressive positions. The smaller properties are more likely to just have mistakes made out of ignorance.

From my understanding of what you are saying, say property A has a $2k washer, and property B has a $1K washer. This is an issue since you are trading down -

Correct.

but what if property A had a $1k dryer and property B had a $3k dryer? Wouldn't the common assets just offset each other since they are like-kind.

Sure. But realize what that means. In a 1031 exchange, you'd have to buy a replacement property that has a more expensive washer AND dryer AND fridge AND stove AND range AND carpet AND window coverings AND fence AND landscaping improvements, AND building. If you don't you're going to have to recapture some of that accelerated depreciation.

This is a weird example, I was just trying to illustrate. I guess I am generally assuming that you will always be trading up in a 1031...

Sure you're going to trade up. But with a cost segregated property, you have to trade up on each and every segregated asset. Any asset that you can't trade up will result in some recognized gain.

Granted, with a big enough gain on the basic real estate, a little bit of tax on the segregated assets isn't going to be a deal breaker. But it does result in you repaying a bit of that tax savings you've enjoyed up to that point.

I'd love to hear your thoughts.

There they are. Another two cents' worth of thoughts.

--Peter