Anne Curry, a seasoned real estate investor with a portfolio of 311 units, recently uncovered a game-changing strategy that transformed her financial landscape. In this advisory blog, we delve into the remarkable tale of how she utilized cost segregation to slash her tax bill by 100%, saving a staggering $167,000. Let's explore this innovative tax strategy and its implications for savvy investors like you.
Unveiling the Strategy: Cost Segregation
Cost segregation is a tax strategy that can provide significant benefits to real estate investors by accelerating depreciation deductions. Normally, depreciation deductions for residential properties must be taken over a long period of up to 27.5 years.
However, cost segregation allows investors to claim these deductions much faster. The strategy involves getting an independent cost segregation study conducted on the property. This study analyzes all components of the property, such as the HVAC system, wiring, plumbing, floors, and walls.
It then assigns accurate depreciation timelines to each component based on its economic lifespan. Components like wiring may be valued to depreciate over 5-7 years instead of the full 27.5-year property schedule.
After the study, investors can offset taxes by deducting a larger portion of depreciation upfront over just a few years, rather than small fractions each year. For example, they may be able to deduct 80-100% of total depreciation value within the first 5 tax years after purchasing a property.
This provides an immediate and significant tax reduction that puts cash back in the investor's pocket. The key benefit is it enables investors to accelerate tax savings and then use those funds to purchase additional income-generating real estate assets.
The Mechanics Behind Cost Segregation
To take advantage of cost segregation, real estate investors must first undergo an independent cost segregation study of their property. This study is conducted by licensed commercial property appraisers and engineers who carefully inspect all aspects of the building.
They then categorize and assign accurate depreciation timelines to each component based on its economic useful life. Components like the HVAC system, wiring, fixtures, and appliances that have shorter lifespans may be valued to depreciate over 5-7 years instead of the standard 27.5-year schedule for residential properties.
Once the study is complete, it provides a detailed breakdown of the depreciation amount that can be claimed for each component over the various eligible periods. Armed with this report, investors can then front-load depreciation deductions on their tax returns.
They receive larger deductions in the early years rather than spreading the total value over the full depreciation schedule. For example, a cost segregation study may allow them to deduct 80-100% of the total calculated depreciation within the first five tax years after purchase. This brings substantial tax savings upfront that can then be used to acquire more income-producing investments.
Tangible Results: Curry's Success Story
Anne Curry had built a sizable real estate portfolio over 25 years, but only recently learned about cost segregation from a podcast. Intrigued by its potential benefits, she decided to undertake rigorous cost segregation studies on many of her 311 units.
The results proved her decision right. Just from the studies conducted on her eligible properties in the single year of 2022, Curry realized spectacular tax savings of $955,733 according to figures from the firm that performed the analyses.
Even more remarkably, by having past tax returns amended going as far back as 2014, Curry was able to further maximize her returns on investment. Depreciation deductions from prior years were recalculated based on cost segregation valuations, enabling her to recoup additional taxes paid.
This led the IRS to issue Curry a hefty $167,850 refund check in 2023. Such an outcome vividly demonstrates just how potent this strategy can be for savvy real estate investors when implemented comprehensively across a large portfolio and numerous tax years. It also highlights why Curry remains an advocate for exploring cost segregation's benefits.
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4. Factors to Consider
Type of Income
Cost segregation is best suited to offset passive rental income rather than active salary. Investors should only pursue it if their portfolio generates sizable passive profits.
Land vs Building Values
Properties, where land value dominates total worth, may have limited eligible depreciation deductions compared to locations where structures hold primacy. Feasibility relies on an appreciable tax basis for improvements.
Portfolio Size
The strategy works best for large real estate holdings as cost segregation studies run $2,000-8,000 each. Small portfolios may not yield sufficient tax reductions to justify study outlays.
Timing in the Tax Code
Deduction percentages are stepped down each year until 2027 under current legislation. Filing now allows claiming higher limits before they step down further.
Property Selling
Claiming cost segregation deductions requires "recapture" of any unused amounts if a property sells prematurely. Investors must account for this in exit strategy planning.
Expert Guidance
Laws around cost segregation can be intricate. Working with a tax consultant ensures full compliance and maximizing benefits suiting an individual's situation.
Depreciation Schedules
Long-term real estate holding remains key as switching strategies too soon forfeits valuable future standard deductions.
Suitability for Large Portfolios
While cost segregation can benefit any investor with eligible properties, the strategy is best positioned for those with sizable holdings like Anne Curry's portfolio of over 300 units. There are a couple of key reasons for this.
Firstly, the cost of individual studies runs in the thousands of dollars, from $2,250 to as much as $8,450 in Curry's case. For small portfolios lacking significant income-generating properties, these upfront costs may not pave the way for ample offsetting tax deductions.
However, investors with large numbers of assets see a very different outcome. When conducting numerous cost segregation analyses across a broad portfolio, the studies’ costs become a Minor expense compared to the cumulative tax savings generated. For someone like Curry with hundreds of units, shelling out tens of thousands on several studies is easily justified by deductions of over $950,000 in a single year.
While smaller real estate operators could still benefit to a degree, only the largest holdings make cost segregation a profitable proposition when weighing its ability to unlock massive tax reductions against initial investment requirements. Scale is a crucial factor for unlocking the full potential of this potent strategy.
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Long-Term Considerations
When employing cost segregation, real estate investors accelerate depreciation deductions by claiming larger portions upfront over a shorter period than standard schedules. However, if properties are sold before 27.5 years, the unused deductions must be recaptured, or paid back, as regular income.
This is an important consideration for exit strategies. Curry mitigates this risk by recommending the substantial tax refunds achieved through cost segregation be prudently reinvested into purchasing more rental properties.
This allows the benefits of the strategy to perpetually roll over into expanding one's portfolio. Larger holdings demand fewer exits in the interim, thus avoiding premature recapture obligations.
Her long-term orientated approach ensures cost segregation fuels perpetual growth and opportunities to continually conduct further analyses on new acquisitions. When judiciously reinvested, these deductions power the type of snowballing real estate empire Curry has amassed. Savvy long-term perspective is paramount for sustained success with this potent strategy.
Expert Guidance Is Key
While cost segregation presents a potent opportunity for real estate investors, navigating its intricacies necessitates expert advice. Curry emphasizes the importance of consulting with tax professionals to ascertain eligibility and maximize benefits tailored to your unique circumstances.
Conclusion
Anne Curry's journey epitomizes the transformative potential of cost segregation in real estate investing. By strategically leveraging this tax-saving strategy, investors can unlock significant savings, propel portfolio growth, and achieve unparalleled financial success.
However, meticulous planning, informed decision-making and expert guidance are imperative to reap the full rewards of cost segregation. As you chart your investment course, consider the invaluable lessons gleaned from Curry's remarkable saga and seize the opportunity to optimize your tax benefits through cost segregation.
Source: How Tax Benefit Cut 100% Of Bill, Saved $167000 Through Real Estate | Business Insider
