Rental property owners able to 'cost segregate'
There is good news for owners of apartment complexes and mixed-use developments with residential rental units: Bonus depreciation is back — for at least the rest of this year and retroactively to Jan. 1.
Bonus depreciation, which allows for half the value of a new asset to be written off in its first year, was extended for this year through the American Recovery and Reinvestment Act, also known as the economic stimulus package. The remaining half then is deducted under normal circumstances, according to the asset’s Internal Revenue Service classification.
Following the terrorist attacks of 2001, Congress enacted the hyper-depreciation process as an economic incentive good through 2004. Lawmakers revived it for 2008, and it came back into play when President Barack Obama signed the recovery bill last month.
Key to the accelerated tax break is that it isn’t just for long-term assets like the structural components that make up a rental property — but only if a building owner segregates the costs, and only rental property owners can cost segregate.
“What it does from a cost-segregation standpoint is, all qualifying assets that are shorter lived — maybe five years, seven years or 15 years — also qualify for bonus depreciation,” said Mark Zettell, director of cost segregation services at BDO Seidman LLP.
Residential rental buildings have a depreciation life of 27.5 years for walls, roofs, floors, and the general heating and lighting systems — the structural components. But to reap the full tax benefits available this year, an owner should probably have a cost-segregation analysis done on the other items that make up a property.
“By doing a cost-segregation study, you can identify construction-related features within the building itself that will qualify for the shorter lived (assets) of five or seven years, or 15 years if it’s a land improvement,” said Zettell.
To qualify for bonus depreciation this year, Zettell said an owner has to have placed an asset into service after Jan. 1 or do so before the year ends. The biggest winners will be owners who began new construction last year on apartments that will open this year.
“As long as it’s commercial residential rental property: all the apartment-type complexes would all qualify as residential rental. If it’s a home, as long as it’s not a home that’s rented out on a transient basis. You really have to have someone there almost full-time for a very long period of time for it to be residential rental,” said Zettell.
“It’s all a facts-and-circumstances test. So maybe some of these cottages that you see along Lake Michigan may not be residential-rental properties. These may be commercial property, but instead of 27.5 years for the cost of the building to be depreciated, these may be 39 years,” he said of the depreciation lifespan for a commercial structure.
Owners of buildings that have a mix of for-sale condominiums and for-rent apartments can use bonus depreciation for the rental properties, although Zettell said the formula to do that is a bit more complex than if the structure only contained rental units.
“Anything that is carved out as residential-rental property is a depreciable asset to the owner,” he said.
Carpets and flooring, but not ceramic-tile floors, are two short-term depreciable assets. Dedicated infrastructure like wiring for appliances, plumbing and venting for washers and dryers are others. So are cabinetry and decorative features of common areas. The IRS classifies these as personal property with a five-year life. And there are more.
“If you have an apartment complex with many buildings and garden-style apartments, you also have land improvements. That would be paved areas — the site’s concrete walks, curbs and gutters — the site’s storm sewer, generally the landscaping, and other exterior features that are constructed. Those would have a 15-year life,” said Zettell.
“So, really, if you’re looking at an apartment — five years, 15 years and 27.5 years, for the most part, covers everything.”
Bonus depreciation only applies to new property. Tax regulations define new property as original use. So new improvements that are made this year to an existing building that is, or will become, rental property can also be bonus eligible.
New owners of existing buildings, though, may not have the contractor’s cost for many of the structure’s components. If that’s the case, then a cost-segregation analysis can help.
“Maybe all you will have is the cost of the building, and at the very first, you have to try to break out the land and building. So that is where you really need someone who knows how to recreate the cost of a building and account for any depreciation of the components,” said Zettell.
“Obviously, the economy is not doing well. The name of the game is cash flow, and anything you can do to increase cash flow by accelerating depreciation deductions helps the business.”