With the return of bonus depreciation, thanks to the One Big Beautiful Bill (OBBB), more businesses than ever are exploring cost segregation. The ability to reduce or even eliminate federal income taxes by using depreciation has a lot of appeal and is quickly becoming a hot commodity for new businesses and existing commercial enterprises alike. While most think of cost segregation helping traditional businesses like office buildings, restaurants, and warehouses, many assume that residential properties cannot qualify.
In truth, homes used for both long and short-term rentals can benefit from cost segregation. As property taxes climb across the nation, many real estate investors are looking for any relief they can find. While cost segregation cannot help with property taxes, it can lead to massive savings in other areas. In this article, we will provide a brief rundown on how investors can use cost segregation for their rental properties.
How Homes Qualify
The primary reason that investors believe that rental homes cannot be used for cost segregation is that personal homes are excluded from the technique by the IRS. While true, this does not exclude homes under certain conditions. If a home is primarily used to generate income, either as a full-time rental property or as a short-term rental (such as an Airbnb), then it can benefit from cost segregation. If the owner uses the property as their personal residence for more than 15 days a year, however, then the home will generally be disqualified. Second homes can be used for cost segregation if they are rented to others for most of the year and are only used by the primary owner for 15 days or fewer.
Rising Home Values Make Cost Segregation More Affordable
Using cost segregation for homes is generally a newer phenomenon. First, many believed that homes were not eligible for cost segregation. Second, an investment in a cost segregation study was not seen as viable. However, with rising home prices, higher property taxes, and rising rents, the prospect of using depreciation has become more and more appealing in the last decade. The return of bonus depreciation has made the proposition even more appealing, and investors can achieve an incredible ROI in many cases.
What Components of a Rental Home can be Used?
Like all cost segregation, the focus should be on classifying real property into categories of five, seven, and 15-year depreciation. Once categorized in this manner, it can be easier to focus on various components. While the home itself is the biggest piece when it comes to reducing income taxes, virtually every part of the home and the surrounding property can be used as well. When business owners do cost segregation themselves, they often overlook obvious components, which can reduce the overall tax benefit.
Fixtures, furniture, appliances, flooring, carpeting, plumbing, and HVAC equipment are all obvious sources. However, components go far beyond just those interior features. Landscaping, driveways, fencing, sheds, garages, decking, and other exterior features can also be added to the mix. Roofing is another exterior feature that often goes overlooked, despite its obvious cost and depreciation. By separating all of these components, an investor can see a large benefit.
Short-Term Rentals
When it comes to properties used for short stays, there can be even more possibilities for depreciation. These often have greater amenities than long-term rentals. This includes electronics, luxury furnishings, entertainment systems, specialty lighting, and other features that traditional residences would not have. Since many of these rentals also have aspects shared with hotels, cost segregation techniques for those types of properties can also be used.
Due to their location in tourist-centric areas, many of these rentals will also have specialty items to match their environment. For beach houses or those on lakesides, there could be docks, boathouses, outdoor showers, gazebos, and HVAC systems made to deal with humid or saltwater environments. Urban rentals could have patios, outdoor kitchens, and landscaping. Cabins, hunting lodges, and glamping accommodations can all have specialized buildings, furnishings, and exterior features as well that need to be accounted for.
Large Portfolios Benefit the Most
While even a single rental home or Airbnb can see a large return on investment from a cost segregation study, investors with portfolios of properties will see the largest gain. Many of these properties can be bundled together, making it more cost-effective to analyze, document, and present. Many firms, including us at O’Connor, offer discounts on cost segregation studies for large investment portfolios, especially if the homes share characteristics and are in close proximity. This can be especially lucrative for planned communities that are built from the ground up with renting in mind. Built-to-rent homes and neighborhoods are becoming a growing trend, and these are tailor-made for mass cost segregation.
The DIY Debate
Many owners of commercial property who are considering cost segregation often wonder if they can do so themselves. While it generally requires working with a CPA, simple cost segregation can be achieved by individuals or businesses. However, these typically leave massive amounts of savings on the table, as laypeople can miss obvious sources of depreciation. Many property owners will also contract with a firm, but will not pay for a site visit. While this will usually result in bigger savings than a true DIY, it generally still allows for more gaps in the collection and cataloging of depreciable assets. Depending on the size of a business, going DIY or skipping the site visit can be more cost-effective. If an investor owns a single rental home, they may be inclined to go for a DIY or for less support from a firm.
O’Connor Offers Flexible Cost Segregation Options for Investors
Whether you own a single home or a large portfolio, we at O’Connor can give you the ultimate support when it comes to cost segregation. Our experts have decades of experience in the field and have carried out this technique across the globe. We have been one of the early adopters of cost segregation, especially for rental homes, and have determined that an engineering-based approach is the best way to get the best results. This means that our experts use the IRS-favored methodology to document, value, and categorize depreciation.
It requires multiple skill sets to perform cost segregation correctly, and we have the people needed to get the best results. We offer support with or without site visits, so you can decide which strategy works within your budget. We will work with your CPA to create a cost segregation report that will stand up against any audit, and we have never backed down in the face of pressure from the IRS or other organizations. For those who have large portfolios of rental properties, we offer substantial discounts, allowing you to shield even more taxes. Reach out today for a free quote and get started on your reduction journey.
Frequently Asked Questions About Rental Home Cost Segregation
Q: Is it worth it to skip a site visit from O’Connor?
A: This depends on the size of your portfolio and your needs. For smaller properties, opting out of a site visit can help reduce the cost by 70%. However, for larger properties and multiple homes, a site visit is highly recommended and usually results in much larger savings.
Q: Does O’Connor offer audit support?
A: Yes, we pride ourselves on never buckling under audit and have always had the backs of our clients.
Q: What is the ROI on a cost segregation study?
A: There is typically a 10-to-1 return on investment, but this can easily be much higher, depending on the size of the business.
Q: What do you charge for the study of a single home?
A: We start with a fee of $1,500 for site visits, though this could be higher depending on the complexity of the residence. We do offer discounts for multiple homes if they are similar in characteristics and are in the same area.
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