Depreciation is one of the most powerful tax-saving deductions available to you as a real estate investor.
However, if you are looking to compete effectively in North Carolina, you cannot sit back and let the IRS take control of your depreciation schedule. If you do nothing, the IRS will gladly depreciate all your property components over 27.5 years (residential) or 39 years (commercial).
That’s less than ideal, as doing cost segregation in North Carolina allows you to depreciate a significant portion of your property much faster. In this post, we’ll explore how cost segregation works and the rules specific to North Carolina.
What is Cost Segregation and How Does it Work?
Cost segregation is a tax strategy that enables you to accelerate the depreciation of your property. You get to separate the shorter-lived components of the property from the longer-lived structural assets, allowing you to depreciate them faster.
For instance, imagine you’ve invested in vacation rentals in Corolla, North Carolina. Picture the typical property by the shoreline. It has:
- Outdoor lighting
- Beautiful landscaping
- Security systems
- In-ground swimming pool
- Built-in hot tub/spa
- Elaborate furniture
- Elaborate cabinetry
- Appliances, e.g., washer and dryer, fridge, etc
Many of these assets, despite accounting for a significant portion of the property’s value, won’t last as long as the core building structure. Therefore, subjecting them to a 27.5- or 39-year depreciation schedule is inefficient.
The IRS agrees. The assets above are categorised under Site Improvements and Personal Property. Here’s how long the IRS expects them to last:
- Personal property: 5 or 7 years
- Site improvements: 15 years
The IRS allows accelerating the depreciation of these assets by subjecting them to depreciation schedules consistent with their actual useful lives.
The process must begin with a cost segregation study, where you’ll classify and allocate costs to various property components. The study culminates in a cost segregation report, which you should have for audit readiness in case the IRS wants you to explain your cost allocations.
Key Tax Benefits in North Carolina
Cost segregation primarily serves to maximize the benefits of the time value of money. You aren’t creating new tax deductions. You will get the deductions you would have gotten anyway, but cost segregation helps you boost them further.
Here’s how cost segregation can benefit you:
- Improved cash position: Accelerating depreciation of personal property and site improvements means you get to take larger deductions in the initial years of property ownership. You’ll reduce your federal and state tax liability significantly.
- Opportunity to grow your portfolio faster: By frontloading depreciation, you also frontload your tax deductions. You can reinvest the money now and get better long-term portfolio performance because you’ll have a longer runway to compound growth.
- Opportunity to qualify for bonus depreciation: Assets with recovery periods of 20 years or less qualify for bonus depreciation. Cost segregation enables you to identify personal property and site improvements with recovery periods of five and 15 years, respectively.
Also called Additional First Year Depreciation Deduction, bonus depreciation allows you to deduct up to 100% of the cost of a qualifying asset in the first year. That means that instead of allocating the cost of a swimming pool over 15 years, you can claim up to 100% of the cost in one lump sum deduction.
It’s a pretty straightforward deduction in most states. However, in North Carolina, you must:
- Add back 85% of the federal bonus depreciation you’ve taken (at the state level)
- Deduct this add-back in five equal installments over the next five years (20% annually)
Therefore, you get to benefit from bonus depreciation, but it’s spread over six years. Even with the deferred benefits, we believe cost segregation is worthwhile in North Carolina because of the compounding power of the time value of money.
A dollar saved in the sixth year is worth more than a dollar saved 28 or 39 years from now.
Who Should Consider Cost Segregation in North Carolina
Since cost segregation studies cost money, you might be wondering what conditions and property values justify incurring the expense.
You should consider cost segregation in North Carolina if you fall into any of the following categories:
- You hold a medium- to high-value property with a depreciable basis exceeding $300,000
- You or your spouse files as a Real Estate Professional (REP), or are a material participant in a short-term rental (STR) (an opportunity to be exempted from passive activity rules)
- You are considering or have undertaken a major renovation (renovations typically add shorter-lived assets that can be depreciated faster)
The Cost Segregation Study Process in North Carolina
At Seneca Cost Segregation, we perform engineering-based cost segregation studies, which the IRS considers more reliable.
A typical study conducted by our team involves the following steps:
Property Review and Data Collection
You can contact us for a preliminary review of your property to establish if it is eligible for a cost segregation study. The review can help you estimate potential tax savings to determine if the cost of the study is worth it.
If you decide to proceed, we’ll start gathering relevant documentation to aid the study. Usually, we’ll request proof of ownership, settlement/closing statement, documentation showing land valuation, construction drawings/blueprints, invoices, and other relevant documents.
Property Inspection and Engineering Analysis
Our engineers will conduct an on-site or virtual inspection of your property. We’ll verify the assets listed in the documentation you provided and identify assets you may have missed.
Our team will then conduct an analysis, using engineering-based costing techniques and industry data to allocate costs to the property components.
Report Preparation and Post-Study Support
We’ll put together a cost segregation report detailing our asset classifications and cost allocations. We’ll also detail the methodology we’ve used to arrive at our decisions.
Your CPA will use the report to prepare your tax filings. We’ll be available to provide post-study support so you and your CPA can implement our findings effectively.
Further, while the risk of an audit is low because we follow IRS guidelines strictly, our post-study support includes the Seneca AuditDefense guarantee. We’ll defend the report in the unlikely event of an audit.
Ready to lower your tax bill with an IRS-compliant study? Contact us today to leverage the experience of our cost segregation team and our network of cost segregation-minded tax advisors and CPAs.
How to Choose the Right Cost Segregation Provider in North Carolina
Using cost segregation tax strategies to accelerate your real estate investment goals can afford you a significant competitive advantage in North Carolina. The IRS recognizes this reality and regularly reviews reports to guard against abuse.
As such, you must only work with the best cost segregation providers, which generally share the following characteristics:
- Engineering-based methodology: The IRS explicitly states in its Audit Techniques Guide that a cost segregation study done by someone with a construction or engineering background is more reliable.
- Industry experience: It helps to work with a team that has handled several properties like yours. For instance, our engineers have completed over 10,200 studies nationwide.
- Audit-readiness: You must be ready for any eventuality, including an IRS audit. A properly done study is unlikely to trigger an audit. However, the provider should offer post-study support and an audit defense guarantee in the unlikely event of an IRS audit.
Estimate Your Tax Savings With Our ROI Calculator
As a savvy investor, you should always be running the numbers. The decision on whether to invest in cost segregation in North Carolina depends mainly on the amount of the initial cash flow boost the exercise will yield.
We’ve made running the numbers easy. You can now use our ROI calculator to estimate how much you can save in taxes this year.
Use our ROI calculator today to see how cost segregation can impact your bottom line. It’s fast, accurate, and IRS-compliant.
Common Cost Segregation Mistakes to Avoid
Working with a reliable provider will help you sidestep most cost segregation mistakes.
Nonetheless, you must still take steps to avoid the following common mistakes:
- Over-aggressive allocations: Unreasonable cost allocations to shorter-lived assets may earn you unwanted attention from the IRS, which could lead to an audit. Cost allocations must not only be reasonable but also defensible.
- Ignoring North Carolina rules: The state decoupled from federal bonus depreciation to cushion state-level tax collection. You still get bonus depreciation, but it’s spread over six years.
- Waiting too long to commission a study: Fundamentally, cost segregation and bonus depreciation are supposed to help you maximize the benefits of the time value of money. If you wait too long before commissioning a study, you’ll miss out on some of the benefits.
Frequently Asked Questions (FAQs)
Let’s answer some common questions about cost segregation:
Will Cost Segregation Affect My Property Value?
No, cost segregation will not affect your property’s actual value.
It will help you accurately classify your property into its constituent components: real property, personal property, and land/site improvements. You can then allocate your depreciable basis accurately and accelerate depreciation where applicable.
That said, if you do accelerate depreciation, your property’s book value will be lower. You can dispose of your property at a price higher than the book value, but you’ll have to deal with depreciation recapture.
What Documents Should I Prepare Before a Cost Segregation Study?
You should prepare proof of ownership documents, construction drawings/blueprints, construction invoices, change orders, inspection reports, appraisal reports, and other relevant documentation.
Do Short-Term Rentals in North Carolina Qualify?
Yes, doing cost segregation for short-term rentals in North Carolina is an excellent tax strategy.
The IRS usually treats rental income as passive. With short-term rentals, however, some conditions allow bypassing passive activity rules. Therefore, if you create a paper loss by frontloading deductions, you may be able to use the loss to offset your W-2 and active business income.
Conclusion
For many decades, cost segregation was a preserve for big-time real estate investors. With the entry of firms like ours into the space, it has been democratized. Everyday investors can now utilize this tax strategy to front-load depreciation, realize significant tax savings, and accelerate their portfolio growth.
At Seneca Cost Segregation, we’ve consistently helped investors like you turn 20-40% of their property costs into immediate tax savings. You too can add cost segregation into your tax planning toolbox, giving you a significant competitive edge in North Carolina.
Contact our team today to request a free proposal. Share your property’s details to receive a savings estimate.
