While you may not be able to retire early, certain depreciable assets in your real estate portfolio may be eligible for early retirement.
We are all familiar with the concept of a cost-segregation study: Recently purchased, constructed or renovated properties may be depreciated over shorter life cycles than the IRS prescribed 27.5 years for residential properties and 39 years for commercial properties. A properly executed cost-segregation study separates the base building from any decorative, ornamental, task-related or non-essential components located inside the building and allow for these components to be depreciated over 5 or 15 years, resulting in large upfront tax savings.
There is another aspect to a cost-segregation study that – although not as well known – offers the potential of huge tax savings. This is known as the “write off component”.
The “Write-Off Component”
What happens when you decide to renovate a property and remove its original assets? (This is a very common occurrence within the hotel and healthcare industries where owners often make such improvements.) The IRS allows you to take a retirement loss on these assets. Assuming you can identify the assets removed, you may be eligible to immediately write these assets off your books.
Many times the write off component is accidently overlooked because the taxpayer decides to push off the study until after the renovations have been completed. Failing to properly catalog and quantify the components of the building before they are torn out makes it impossible to accurately pinpoint what was removed, therefore no longer allowing them to be written off immediately and taken off the tax books.
The one caveat to this is when the improvements are so substantial and immediate after the purchase that the IRS will look at this entire property as a land purchase and allocate the entire purchase price as such.
Next time you are considering doing a major renovation on a property (even one you don’t own yet but are planning to buy), consult with your accountant and a proactive cost segregation specialist to ensure that you take advantage of every tax benefit… and ensure that your ghost assets go into early retirement.