How To Cut Taxes On Investment Property

Q: I just bought a big multi-unit property and I’ve got a huge tax bill I have to pay this year. What can I do to reduce the tax bill? Dale, Farmingdale, NJ

A: One way you can reduce your tax burden as a property owner is by componentizing your property. Componentizing property is a tax strategy known as cost segregation, which allows real estate investors to accelerate depreciation deductions on certain components of a property. Cost segregation provides property owners with larger tax deductions in the early years of ownership which can also increase their cash flow.

Here’s how cost segregation works: When you buy a commercial or residential rental property, the building structure is typically depreciated over 27.5 years for residential property and 39 years for commercial. A qualified professional, performs an analysis or cost segregation study on a property to identify and reclassify components into shorter-term asset categories. By shifting a portion of the property’s costs to shorter-lived categories, you can claim larger depreciation deductions in the early years of ownership. Larger deductions early on can significantly lower your taxable income in the first years of owning the property.

Property owners that can benefit most from cost segregation typically are those that have bought, constructed, or renovated a property in recent years. It is important to remember that componentization is a tax deferral strategy, not a permanent tax reduction. You are accelerating your depreciation deductions to claim them sooner. This means that less depreciation will be available in later years, which can affect the tax you owe when you sell the property. It’s best to speak with an experienced expert to ensure the study is accurate and defensible. My recommendation is to contact Geraldine Serrano, The Cost Seg Queen if you’re interested in componentization. Thanks for your question, Dale.

For more real estate tips and information, visit my blog at geraldlucas.com.