Cost segregation is a powerful tool that can benefit retirees who own commercial properties by optimizing their savings and offsetting taxes — particularly when it comes to converting a traditional IRA to a
A quick primer: Cost segregation involves accelerating depreciation deductions by identifying and reclassifying specific building components. It requires a study that involves a detailed analysis of a property to identify components that can be depreciated over shorter periods. This results in larger depreciation deductions in the early years, which can significantly reduce taxable income and increase cash flow.
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Retirees who own
Here's an example: "Sarah," a retiree who owns a small office building that she rents to various businesses, relies on this rental income as part of her retirement plan. She can reclassify components like electrical wiring and plumbing as shorter-lived assets by conducting a cost segregation study. This allows her to take larger depreciation deductions in the early years, reducing her taxable income and increasing her cash flow.
Or take "John," a retired real estate developer who still owns several properties from his earlier projects, including a mixed-use development with retail and residential units. Through a cost segregation study, John can identify specialized lighting fixtures and
Cost segregation can also be a practical method for retired physicians who own medical facilities. "David," a retired physician, owns a medical office building that he leases to other health care providers. Through a cost segregation study, David can reclassify specialized equipment for accelerated depreciation such as MRI machines and surgical tools.
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Retirees who own manufacturing or industrial facilities can also benefit from cost segregation.
Let's say "Tom," a retiree who previously owned a manufacturing business, still has ownership of the factory building and is leasing it to a new operator. Tom can identify components like production machinery and specialized electrical systems that qualify for accelerated depreciation through a cost segregation study. As with the above examples, cost segregation can significantly reduce his tax burden, enhancing his retirement savings and allowing him to reinvest in other properties or savings vehicles.
IRA to Roth IRA
Cost segregation can also be a helpful strategy for retirees looking to convert a large traditional IRA to a
"Lisa," who owns and rents out a commercial property, has a large traditional IRA she wants to convert to a Roth IRA to benefit from tax-free withdrawals in the future. By conducting a cost segregation study, Lisa identifies building components such as electrical systems, plumbing and any specialized equipment that can be reclassified for accelerated depreciation. This will allow Lisa to take more significant depreciation deductions in the current year, thus reducing her taxable income.
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The accelerated depreciation deductions from the cost segregation study create tax savings, which can offset the taxable income from converting her traditional IRA to a Roth IRA.
Here's how: Lisa converts $200,000 from her traditional IRA to a Roth IRA, resulting in $200,000 of taxable income. The study identifies $150,000 worth of assets that can be depreciated over a shorter period, allowing Lisa to take $50,000 in additional depreciation deductions in the first year. The $50,000 in additional depreciation reduces Lisa's taxable income from $200,000 to $150,000, resulting in lower overall tax liability for the year.
Cost considerations and alternative strategies
Although cost segregation can work in a variety of situations, there are some limitations that need to be considered. The cost of a cost segregation study can be significant, ranging from $7,500 to $15,000. Therefore, it's crucial to weigh the potential tax savings against the price of the study. In addition to the cost, not all properties will equally benefit from cost segregation. Properties with fewer depreciable assets may need to provide more tax savings to justify the expense.
Tax-loss harvesting and
With
If cost segregation is not advisable or financially feasible, retirees can consider other strategies to offset the taxable income from an IRA to a Roth IRA conversion.
One strategy is the
For retirees, cost segregation offers a strategic advantage in reducing tax liabilities, enhancing cash flow and optimizing retirement savings. By understanding and leveraging cost segregation, retirees can make informed decisions to improve their financial health and secure a stable retirement. Consulting with a tax advisor and a cost segregation specialist is crucial to maximize these benefits and ensure compliance with tax regulations.