What Are The Classes Of Property In Real Estate?
Investment rental properties can be classified in several ways, from the type of property to specific building components for cost segregation. Here's what you need to know about the classification of real estate.
If you’re a real estate investor or plan to invest in the future, it’s important to know the basics of residential rental properties, starting with the various classifications.
In this post, we’ll break down how to classify rental property, from property types and classifications by property age and location to classifications used for writing off accelerated depreciation.
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What Are The Classifications Of Rental Property?
Rental property (and real estate in general) can be classified in several ways. First, it can be classified by the type of building, which includes:
- Single detached
- Multi-unit buildings (i.e., apartments)
- Mobile homes
Real estate can be further classified into four categories based on factors such as the age and location of the property. Building components of the property can further be classified to accelerate depreciation through cost segregation. We’ll explore these various classifications throughout this post.
4 Types Of Real Estate Property Classes
Investment real estate properties are generally broken into four classes. While some investors only consider the age of the property, other factors can also help you determine the asset class of a real estate property.
Class A Properties
Class A properties are the best of the best. These homes are newer homes that were built less than 10 years ago. Other characteristics of Class A properties include:
- Newer homes with luxury upgrades
- High property values
- High rent potential
- Low-crime areas
- Good school districts
- Desirable areas with many amenities
Class B Properties
Class B properties have been built within the last 10 to 20 years. Similar to Class A properties, these homes are newer and among the more desirable of homes, with characteristics like:
- Builder-grade finishes
- Moderately high property values
- Low vacancy rate
- Low-crime areas
- Good school districts
- Desirable areas with easy access to amenities
While not as luxurious or as new as Class A properties, Class B properties are generally much more affordable for real estate investors.
Class C Properties
Class C properties have been built within the last 20 to 30 years. While these properties may not be as desirable and may require more maintenance, they are generally much more affordable for investors. Here’s what to expect from a Class C property:
- More upgrades, repairs, & maintenance are generally required
- Occupied by low- to moderate-income tenants
- May have some access to amenities
- May have some access to good schools
- Moderate crime rates (generally non-violent)
Class D Properties
Class D properties are much older properties that are often in various stages of neglect. While these are the most affordable properties for investors, the returns are much lower. Characteristics of Class D properties include:
- Generally quite inexpensive but typically require extensive upgrades, repairs, and maintenance
- Low- to mid-ranked schools
- Must travel further for more desirable amenities (i.e., well-maintained parks, high-end shopping centers, nice restaurants)
- Higher crime rates
How Rental Property Classifications Affect Depreciation
One tax break for real estate investors is depreciation. In short, depreciation allows the property owner to write off the cost of the property over a certain number of years. For residential real estate, the property is typically depreciated over 27.5 years.
All investment rental properties can be depreciated, regardless of what type of property you own (i.e., single-family home or multi-unit building) or what class it falls under.
If you’re a new investor, learn more about rental property depreciation and other ways you can save on your next tax return.
Classifying Rental Property Components With Cost Segregation
As mentioned in the previous section, a standard straight-line depreciation of 27.5 years is typical for investment rental properties. If this method is used, 3.636% of the cost basis of the property is written off each year for 27.5 years. However, investors can cash in on additional cash benefits with a technique known as cost segregation.
A cost segregation study is conducted to assess and categorize individual building components of the property. Certain components may be written off over a much shorter period of five, seven, or 15 years. For rental properties, this includes everything from furniture and appliances to shrubbery and fences.
Cost segregation can be used to accelerate depreciation for building components for investment real estate that was purchased, built, or remodeled. While it is recommended to complete a cost segregation study in the first year the property is put into service, look-back studies can be done later so owners can still retroactively claim the benefits of accelerated depreciation.
Many investment property owners can realize the benefits of cost segregation. If you’re unsure if this strategy is right for you, start with a free feasibility analysis with one of the best cost segregation companies. You can find out if you qualify for cost segregation and see how much you could save on your next federal tax return.