By Jason Watson, CPA

Posted Thursday, May 9, 2024

Cost segregation or costseg as the cool kids say allows you accelerate depreciation (and therefore lower taxes and increase cash) on real estate. With a cost segregation report or a cost segregation study (CSS), all the bricks are figuratively torn down and put into different piles. Some piles are eligible for instant depreciation through bonus or possibly Section 179, and the remaining pile might revert to the 27.5- or 39.0-year typical rental or business use depreciation schedule.

Technically and with full-on geek-speak, cost segregation separates property elements that are “dedicated, decorative or removable” from those that are “necessary and ordinary for operation and maintenance of the building.” These piles are called asset classes, and they are maintained separately within your property’s depreciation schedule. Without cost segregation, your fixed asset listing (aka depreciation schedule) for real estate or a rental property would contain-

• Land
• Building
• Acquisition Costs*
• Loan Costs

We sometimes tack acquisition costs onto the building directly, however we usually list them as a separate asset for breadcrumbs or legacy purposes. When a cost segregation report is implemented into your tax return, the Building asset above is chopped up typically into four new assets-

• 5-Year
• 7-Year
• 15-Year
• 27.5/39.0- Year (the remainder, 27.5 for long-term rental and 39.0 for commercial or short-term rental)

From there, and with the help of bonus depreciation and in some cases Section 179 depreciation, you compress the multiple years into one. Yay! Whether this accelerated rental property depreciation yields a tax deduction / tax benefit and therefore increased cash flow (an improved IRR) is contingent on three general things-

1. Short-term rental (7 days average guest stay + material participation), or
2. Real Estate Professional designation, or
3. Net rental income (profit) that can be reduced

Or some combination of the above. Ok, cool, right? How do we get this going? As stated above, CostSegEZ is WCG’s preferred provider of cost segregation reports. According to their website,

Cost Seg EZ is a web-based tool that helps real estate investors identify cost segregation opportunities and maximize their tax savings. Our tool is based on detailed models, 12+ years of experience, and over 1,000 cost segregation studies completed, which informs our calculations and allows us to identify the types of assets that can be segregated and accurately estimate the costs associated with those assets. Simply input information about your property and generate a cost segregation report in just a few simple steps. It’s that easy to unlock the power of cost segregation with Cost Seg EZ.

Their cost structure is super simple (as of May 9, 2024). $395 for under $500,000, and then $100 for each $500,000. Huh? How about this-

• Less than 500k is $395
• 500k to a cool mil, $495
• 1m to 1.5m, $595
• 1.5m to 2.0m, $495
• Over 2m, a fully engineered report is needed with a custom quote

Cost segregation studies used to be for the rich and shameless with some reports being several thousands of dollars. While those still exist and are even needed at times, you can see that is not the case with CostSegEZ. Sure, there are other do-it-yourself costseg providers, but WCG CPAs & Advisors has worked with CostSegEZ multiple times, and we like their approach and customer support. Most real estate investors in the single-family home or small apartment building space only need a simple report.

Keep in mind that CostSegEZ and their competitors are considered do-it-yourself cost segregation reports. You are the doing the site visit. You are collecting data. You are typing that data into a model. As such, you can mess it up badly. Prior deprecation already taken and improvements seem to be the frequent things that trip people up. So, in any garbage in garbage out scenario (think QuickBooks), you might need guidance on the inputs.

Cost segregation is a wonderful tool and doesn’t cost a bunch of money to implement. A win-win. All the flavor with no calories. Wait! There’s more… should you benefit from a cost segregation study and the related big tax deduction, then perhaps pairing this with a Roth conversion on your traditional IRA makes sense as well.

Jason Watson, CPA is a Senior Partner of WCG CPAs & Advisors, a business consultation and tax preparation CPA firm located in Colorado Springs, and is the author of Taxpayer’s Comprehensive Guide on LLC’s and S Corps which is available online and from mostly average retailers.