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segmented depreciation

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

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

As we look at our rental property tax deductions, segmented depreciation, or cost segregation as some accountants call it, can work largely in our favor. You see, the beauty of depreciation when it comes to investing in real estate 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’s an example:

You have a duplex valued at $250,000. You could put it on a 27.5-year depreciation schedule, or you could segregate your shorter-lived assets.

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

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

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

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

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

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

You may have realized that the $40,000 in 5-year assets will be phased out after 5 years and the $20,000 in 15-year assets will be phased out over 15 years.

Yes, that’s true, but the reality is that 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 very worthwhile to do a segmented depreciation.

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