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How the new tax law affects cost seg/Section 1031 exchange combos

Savvy real estate investors in New York may prefer to explore potential tax saving options like combining cost segregation and Section 1031 exchanges. Due to provisions in the Tax Cut and Jobs Act, or TCJA, this particular strategy may be even more important for investors. The TCJA has modified rules that apply to Section 1031 exchanges and expanded applicable depreciation rules. These changes present new opportunities that some investors may not know are available.

One newly available tax planning strategy involves IDing short-life assets that will be fully depreciated with a cost segregation study. Because these no-value assets are not part of the Section 1031 exchange, there is no depreciation recapture that has to be reported as income. With a cost segregation study, tax-paying real estate owners may be able to reclassify some assets as Section 1245 properties instead of 1250. Doing so allows for depreciation over a shorter period of time.

The purpose of Section 1031 of the tax code is to delay paying taxes on gains from investment or business property sales. With strategic planning, such taxes could be deferred indefinitely. Under the TCJA, Section 1031 exchange rules now apply to real property but not personal property. Eligibility for a Section 1031 exchange deferment is based on each state's definition of "real property." Sections 1245 and 1250 distinctions are still the same. Under the right circumstances, a property may be claimable under 1031 and depreciable as a 1245 property. Cash flow generation potential may be further improved with a cost segregation analysis because of updates to Section 179 pertaining to nonresidential property improvements.

When a real estate investor is considering taking advantage of a 1031 tax deferred exchange, a lawyer may offer advice on whether or not performing a cost segregation study is a good idea. An attorney may also be able to identify other opportunities for income tax deferral or recommend strategic ways to retire certain property-related assets, especially if there is a pressing need to boost immediate cash flow.

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