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Rental Property Cost Segregation

A rental property can have larger depreciation deductions in its first years by separating out property components.

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cost segregation

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Cost segregation is a process very closely related to the concept of chattel. Indeed, chattel (i.e. personal property) is one of the items separated out from a real estate purchase when performing a cost segregation. It all relates to speeding up the depreciation expense available on your rental property.

Even a small rental property can be divided into four parts:

· Land
· Building(s)
· Land Improvements
· Personal Property (chattel)

Each of the classifications above has its own depreciation schedule except for the land which cannot be depreciated. The building(s) (the house and garage) are depreciated over 27.5 years. Land improvements like driveways, fences, some landscaping and walkways are 15 years. Personal property (kitchen appliances, carpets, etc.) is depreciated at a five year rate. The idea behind a cost segregation is to break out (tax wise) the individual parts of your real estate investment so that you can take your depreciation expenses as quickly as possible by depreciating each class individually.

Even though not commonly done on residential rental property the concept is perfectly valid. Commercial properties are treated this way quite often. The trick is in determining the individual values in an accurate way that will pass muster with the IRS. For larger commercial properties there are firms that provide full engineering reports that can be quite expensive. Obviously this is prohibitive for a small residential rental property.

Fortunately, for small investors there are other ways to get this done. Two methods are worth mentioning here. First would be a very "do-it-yourself" approach using the Craftsman Book Company's latest cost estimating guides (http://craftsman-book.com/). A more "hand holding" approach can be done via Marshal and Swift's online tax segregation software (http://www.taxsegexpress.com). With this service, for around $200 you can perform a very thorough segregation on your single family rental property. You may, however, want to hire someone knowledgeable to assist with the process. A licensed home inspector should be able to perform this process accurately.

What can be gained? If even $15,000 in five year class personal property can be separated from the property as a whole then that's $15,000 in depreciation deductions you'll receive over the next five years that you would have normally had to stretch out over 27.5 years!

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