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Can Cost Segregation Offset W-2 Income?

A. Chris Ostler, CPA

January 5, 2024

Whether cost segregation can offset your W-2 income depends on the specific circumstances of your situation, with two key factors playing a crucial role:

1. Passive Activity vs. Active Activity:

Passive activity: Real estate generally falls under passive activity, where losses cannot offset W-2 income without meeting specific requirements. You need to materially participate in the real estate activities to utilize passive losses towards W-2 income. This involves actively managing the property, performing repairs, and making substantial decisions.

Active activity: If you're a real estate developer, broker, or actively manage multiple properties full-time, your income might be considered active, where cost segregation deductions can directly offset your W-2 income.

2. Passive Activity Loss Rules:

Even with material participation, passive activity losses exceeding passive activity income can't be used to offset W-2 income in the current year. They get suspended and carried forward to future years when passive activity income becomes available to offset them.

In most cases, cost segregation alone cannot directly offset your W-2 income unless:

  • Your real estate income is considered active due to your involvement.
  • Your passive activity losses do not exceed your passive activity income in the current year.

However, cost segregation can still be advantageous even if it doesn't directly offset W-2 income:

Increased cash flow: Accelerated depreciation allows you to claim larger deductions each year, potentially leading to higher cash flow from your investment property.

Reduced future tax burden: Suspended losses can be used in future years against passive income or when you sell the property, lowering your overall tax liability.

Recommendations:

Consult a tax professional to determine how cost segregation applies to your specific situation, considering your activity level and income sources.

Understand the passive activity loss rules and how they might impact your tax deductions.

Consider cost segregation as part of a comprehensive tax-planning strategy alongside other potential tax saving options. Remember, tax laws are complex and subject to change. This information is not a substitute for professional tax advice. Always consult with a qualified tax advisor to ensure you're maximizing your tax benefits and complying with all regulations.

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