Segmented depreciation

I love segmented depreciation. To understand the value and beauty of this, let’s take a look at what depreciation is.

In accounting, you can write off a certain amount of depreciation as a cost or loss. You see, the IRS considers your assets to be “spent” and they become less valuable over time. For example, if you own a trucking company, you can depreciate your trucks because they are wearing out and are less valuable. It may be a non-cash expense from year to year, but one day you will have to replace those trucks.

Looking at our rental property tax deductions, segmented depreciation or cost segregation, as some accountants call it, can work a great deal in our favor. You see, the beauty of depreciation when it comes to real estate investments is that our properties are most likely going up in value.

For years, real estate investors put their properties on a 27.5 straight-line depreciation schedule. But in reality, you may have some assets attached to that property that won’t last anywhere near 27.5 years. Instead, you can depreciate them sooner, like 5 or 15 years.

Here is an example:

He has a duplex valued at $ 250,000. You can put it on a 27.5-year depreciation schedule or you can segregate your short-lived assets.

If you choose to segregate and do segmented depreciation, you could depreciate $ 190,000 over 27.5 years and depreciate $ 40,000 over 5 years and $ 20,000 over 15 years (for example).

The 5-year assets are usually things like carpets, appliances, curtains, etc.

15-year assets are things like fences, driveways, patios, etc.

Which method is better segmented or linear? We’ll see.

If you choose to depreciate the $ 250,000 over 27.5 years, you will have an annual depreciation of $ 9,091.

If you choose segmented depreciation, your annual depreciation would be $ 16,242!

However, you may have discovered that the $ 40,000 in 5-year assets will phase out after 5 years and the $ 20,000 in 15-year assets will phase out in 15 years.

Yes, that’s true, but the reality is, you’ll be replacing those assets anyway, which starts the cycle all over again. You will most likely have to replace the carpets after 5 years in a rental.

So in most situations, it is worth doing a segmented depreciation.