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May 23, 2024 | read

76. How The Residential Cost Segregator Can Save Small Property Owners Thousands

Ben Isley

Today we’re joined by John W. Hanning, principal at KBKG, a company that specializes in cost segregation. 

As you may know, cost segregation studies break down the components of a property and reclassify certain components into 5, 7, and 15-year property that can be depreciated faster and over a shorter amount of time using accelerated depreciation methods. In addition, the Tax Cuts and Jobs Act of 2017 reintroduced 100% bonus depreciation for property with a class life of less than 20 years. These increased depreciation expenses will allow real estate investors to have rental losses that can be used to offset rental income and, in some cases, offset capital gains and ordinary income as well. At the end of the day, these depreciation deductions will drive down income.

Using cost segregation and bonus depreciation together can result in depreciating 20%-30% of a property’s cost basis in the first year it’s placed into service – major tax savings.

The problem is that cost segregation studies can cost thousands of dollars, limiting their viability for smaller properties.

In this episode, we will discuss KBKG’s cost segregator software. This allows owners with smaller properties (500K basis or 6 units or less) to engage in cost segregation without the issue of price.

KBKG Software – The Residential Cost Segregator

The software performs a cost segregation study in situations where a traditional cost segregation study would be prohibited by price. This tool is geared to a single-family home up to a 6-plex with a property basis of $500K or less. This segment of the market is not served by cost segregators at all. This tool was created for this specific type of property – not warehouses or other structures.

CPAs are using this software in-house at their firms. Other real estate investors are using the tool on their own. Tax experts in general use this tool to add the most value to clients.

$400 for one report. Three different reports are summaries (tax deductions, NPV), detailed results (units of property level per category), and a summary of everything that was entered into the software.

Why Is There an Upper Limitation?

The software uses algorithms to extrapolate some results. As the price rises above $500K, the standard deviation and error increase. The lower the basis is, lower is the opportunity for error.

Audit Protection

KBKG provides 8 hours of audit support with all studies. This applies to this software tool as well. In the worst case scenario, KBKG will do a traditional cost segregation study to prove that the results support the output of the software.

When is the Best Time for a Cost Segregation Study?

You could go back to 1987 for a look-back study, but a good rule of thumb is no more than 10 years past. However, it’s best to do a cost segregation study in the year of purchase because there is no change in accounting method to deal with and you can avoid amending returns. Additionally, it’s better to do the study pre-renovation. This study is a snapshot of time, and this snapshot is from the time the property is acquired. This can be difficult to discern when renovations have been done.

What if the Property is a Short-Term Holding?

If the property is being held five years or less, it may not be advantageous to do a study. This tool applies to investors buying and holding property or those who are building a portfolio. If the investor is a real estate professional, there may be a grouping election that allow them to take those deductions anyway and offset income. At the end of the day, a tax professional should help determine the value of a cost segregation study in this scenario.

Find the Residential Cost Segregator and other KBKG resources: www.kbkg.com/residential-costsegregator

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