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Are you Taking Full Advantage of Depreciation Deductions on your Rental Property?

By Caryn M. Feldman, CPA, MST

In any economy, real estate owners are always focused on their internal rate of return. However, in periods of economic decline, savvy real estate owners seek out opportunities to improve their bottom line. A tax break called “cost segregation” can produce significant tax savings that can be realized immediately.

Most taxpayers who own residential rental property depreciate the entire cost of their building over 27.5 years. Those who own other types of buildings, such as offices, retail space, grocery stores, restaurants, warehouses, and manufacturing plants often depreciate the entire cost using a 39-year or 31.5-year depreciation period, depending upon the date of acquisition. However, according to the IRS cost segregation guidelines, a substantial portion of a building’s cost can be depreciated over much shorter periods, usually five or seven years!

A cost segregation study acceptable under IRS standards is an extensive review that analyzes a property’s construction to isolate its structural components. The cost segregation rules are complex, but in short, they enable a real estate owner to depreciate those components of a building that are unrelated to its “operation and maintenance” over a shorter depreciation period. Moreover, these depreciation deductions are calculated using an accelerated depreciation method, which allows costs to be recovered at twice the rate applicable to the real estate property itself (typically 27.5 to 39 years).

The shorter depreciation period and accelerated depreciation method can apply to many types of building components. It is impossible to list them all, but some common examples include molding, millwork, and other decorative elements, carpeting, wall coverings, partitions, window treatments, counters, cabinets, shelving, special lighting, specialized machinery and equipment (such as kitchen equipment), and the costs of plumbing and electrical allocable to such equipment. In addition, certain land improvements located outside the building can be depreciated over 15 years. These land improvements can include landscaping, fences, sidewalks, curbs, parking lots, lighting, utilities, signs, swimming pools, tennis courts, and playgrounds.

Cost segregation studies are applicable to properties that are newly built, rehabilitated or acquired. Depending on the type of building, you can expect to deduct between 10 and 60 percent of its cost over the shortened recovery periods.

Caryn M. Feldman, CPA, MST is a tax manager at Walter & Shuffain, P.C. located in Norwood, MA, a public accounting firm providing tax, audit and business consulting services to individuals and closely-held businesses. For more information on cost segregation studies, please call Caryn at 781-769-5300 or e-mail her at cfeldman@wscpa.com.
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