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In this blog, we are going to discuss depreciation deductions from your income tax and the utilization of cost segregation. Say you purchase a building for $1,000,000, $700,000 of that would be depreciable based on the 70/30 split of land and building which is pretty much standard. Under IRS code section 1250, allow you to deduct that $700,000 over a 39 year period. Or about $18,000 per year. Let's assume you're making 10% of your money and you're making $100,000 per year on your investment, minus $18,000 per year for depreciation. This would make your taxable income total $82,000.
Here is what happens with cost segregation. You have a property that costs $1,000,000, and $700,000 of that is not land that you can deduct. Now lets say there's a rebuilt electrical system or heavy duty HVAC system in the property. Now the IRS sec 1245 allows you to accelerate that depreciation over 5, 7 and 15 years based on the items. In order to do this, you need to have a cost segregation analysis come in and generally, they get a percentage of the first year's savings in taxes.
For example, let's say they do the cost segregation analysis and they come up with $200,000 is deductible over 5 years, that $200,000 will get you $40,000 a year depreciation over 5 years and the other $500,000 will be deductible over the standard 39 years which is about $12,800 dollars. So your depreciation is going to be $52,800 for the first 5 years. Now instead of $100,000, you take $52,000 off of that and you will be paying $48,000 on taxable income even though you made $100,000.
Now, standard youre going to pay tax on $82,000 versus the cost segregation method which would allow you to pay taxes on $48,000. As you can tell, if you're in a 28% or 29% tax bracket, and you're maxed out on your deductions, this is going to make a significant difference to your annual tax flow in the first five years you have that property. It's not an end all and not everybody should do this but it depends on your own financial structure and how long you're holding onto that property, but you should seek the advice of a tax income professional.
If you need help with this, we can direct you in the right direction. Contact Ray at 203.380.8762 or ray@theraymartinagency.com .
Sincerely,
Ray Martin Easton, CT
Ray Martin, Ray Martin Stratford, Ray Martin Easton, Ray Martin Connecticut, Ray Martin Real Estate, Martin Caselli