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Cost Segregation for your Rental Property: Demystifying Tax Benefits for Residential Rentals

A. Chris Ostler, CPA

December 7, 2022

Residential real estate probably is not the first property type to come to mind when discussing cost segregation. In fact, there are many misconceptions that exist around residential real estate and tax deductions. It is heavily advertised that commercial properties benefit from cost segregation, but residential properties used for rental activities can benefit as well.

With a significant rise in short-term rentals, and the ease of management with third party applications such as Airbnb and VRBO, it is important to discuss the available tax strategies that exist for these types of rentals. There are a few categories to consider when thinking about rental property including multi-family homes, apartment buildings, and residential rentals. The residential rentals also fall into a handful of their own categories including short-term rentals, long-term rentals, and house hacking (renting out a portion of your home while still living in the rest).

The details can be daunting, and should be left to a professional tax firm. But, it is important to understand the basic concepts in order to have the conversation as a property owner. Most residential rental properties qualify for business tax treatment if the landlord occupies the building less than 10% of the time. In the case of house hacking, the depreciation would apply to the portion of the property rented, not the area being owner occupied.

What is Cost Segregation?

Cost segregation is the reclassification of building components into their shortest allowable class lives. This strategy front-loads depreciation and offsets tax liability giving you extra cash early on when you need it the most. In the case of residential rental properties, the building can be depreciated over 27.5 or 39 years, depending on exact usage details.

Engineering-based cost segregation studies should always be performed by an experienced and credible firm. As you can probably tell by now, tax strategies for residential rental properties can be complicated – you’ll want to be sure you trust the people handling your finances.

A cost segregation study involves a multi-step process, including a physical inspection of the residence, land, and all related assets. The provider will prepare calculations and findings presented in the form of a report. This report is delivered to the property owner and their tax preparer to be used in computing depreciation expenses on their rental properties. It is worth noting that your cost segregation provider should offer complete audit protection in the unlikely chance that you find yourself in a position of need.

Why Consider Cost Segregation for a Rental Property

So why the focus on residential rental property? What makes this industry so unique? When it comes to cost segregation, residential real estate is often overlooked. It is as much work as a commercial property and often yields a smaller result. While that may deter some companies, our goal at Veritax Advisors is to provide everyone with a maximum return on their investments. Overlooking this tax strategy means leaving money on the table.

It will be challenging, but also rewarding

Most of our clients who own residential rental property are not in the tax business. Learning about strategies and benefits can feel overwhelming and often not worth it. We want to assure you that we know your options inside and out. Working with a trusted provider means more cash flow, more passive income and peace of mind that you are tax compliant. Let us help you reach your financial goals through rental property with proper tax planning and advanced strategy!

Vertiax Advisors is experienced in tax law. We have taken the time to understand the residential rental industry. With us as your trusted advisor, you can rest assured that you are in good hands. We guarantee excellent results, we will defend you in the unlikely case of an audit, and we will strictly adhere to all federal and state tax laws regarding rental properties.

For more information or to chat about your property, reach out to our founder Chris Ostler, CPA today.

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