My friend, Dave Sullivan, asks the following question about "component" depreciation:
I was wondering if rental real estate held in an LLC can use component depreciation for accelerated paper losses, and a resulting higher monthly cash on cash return? I read component depreciation could be used in Robert Kiyosaki's real estate book, but then saw this online:
"Component depreciation
At the end of a seminar to a religious group, he says he (Robert Kiyosaki) recently did a real estate deal where he got a 17% cash-on-cash return and that "there's 24% component depreciation on the property." Really? Gee, and I thought component depreciation was explicitly outlawed by the Economic Recovery Tax Act of 1981. Actually, I'm sure of it. It's right there in Section 168(f)(2) of the Internal Revenue Code."
A: I'm not sure where Dave read this comment about component depreciation, but the person making the comment is simply misunderstanding the difference between component depreciation and cost segregation. While it is true that "component" depreciation was eliminated with ERTA (the 1981 tax act), we can still do what we now call "cost segregation." After the 1986 Act, the IRS initially believed that cost segregations were still outlawed. However, this position by the IRS was overturned by the courts, notably in the Health Corporation of America (HCA) case in 1993. With this case, the IRS finally gave in and formally announced that it would allow cost segregations for property placed in service after 1986. There is even an IRS audit guide that specifies how a cost segregation must be done in order to be allowed by the IRS.
A cost segregation, while technically not component depreciation, has the same effect as component depreciation, just under the "new" (i.e., post-ERTA) depreciation tables. This means that we can segregate the costs of the building, the building fixtures (e.g., cabinets, ceiling fans, window coverings), and land improvements and depreciate them under the appropriate rates for those types of items. Typically, a cost segregation will result in much more depreciation in the early years of building ownership which can put a lot more money in the pockets of the owners through lower taxes.
At ProVision, we recently developed a home-study course about how to maximize your depreciation deductions. Look for it's release in the coming weeks at http://www.provisionwealth.com/products.
So when you are buying a building, consider performing a cost segregation following the IRS guidelines. IRS guidelines require an outside professional, such as ProVision, to do the cost segregation. Contact us at 866.467.5809 or cs@provisionwealth.com for more information on how we can help you maximize your depreciation deductions.
Warmest regards,
Tom
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