For those who are building a rental property, the objective when completed is to rent the unit and at the end of the year have a cash flow profit. Of course, you want to hold on to this cash flow as much as possible. So, how can we do that in an tax efficient way?
A cost segregation study is a report issued by your CPA that analyzes and segregates the various components of the build into a way to accelerate depreciation expense. Unlike some countries, Costa Rica does not promote the use of high write off methods for investment. Many buildings for example are depreciated at a 50-year straight-line method or 2% per year. Some items such as furniture may be written off over ten years. The point is that if you have done construction, your property, if not analyzed properly, will be stuck with applying a minimum depreciation life that will not provide much of a cost shield against income taxes.
A cost segregation study allows you to maximize the depreciation write off in the early part of the project, which will allow for a substantial reduction in Costa Rican tax obligations. Many times, the early years of the application of the study, will allow for a zero-income tax obligation.
Let’s go through a quick example. If you build a home for $500,000, then without a proper segregation of the costs, you would be allowed a 2% depreciation rate or $10,000 expense per year. If you had a cash flow profit of $35,000 on rental revenues of $80,000, then you would pay $2,500 ($35,000 less $10,000). If the rentals exceeded about $95,000, then you would pay double as the tax rate goes to 20%. However, lets say you have a cost segregation study performed, our experience is that you would be able to write off about 7% per year for the first ten years of the project. This would mean you would have a $35,000 expense per year and that profit of $35,000 in the above example would be reduced to zero; thereby, your income tax obligation would be zero. Under this example, that could save you between $25,000-$50,000 in real tax obligations.
There are other benefits for the cost segregation study as well. The documentation of the cost basis provides support for the tax authority in the case of an investigation. It provides the cost basis that is necessary in the case of a sale of the property in terms of computing the gain on the sale both in Costa Rica and your home country. It provides a basis for insurance purposes on the cost of replacement of the property. Finally, it acts as support for the declarations for the municaplidad for your real estate taxes (which has to be done every three years).
If you are a developer, you can offer this study to your clients as an add-on – this would be a nice benefit for those purchasing properties in a project that would be rented.
If you would like to learn more of how to save taxes in Costa Rica, please contact us at firstname.lastname@example.org.
This article carries no official authority, and its contents should not be acted upon without professional advice. For more information about this topic, please contact our office.