Real Cash Flow Opportunities for Commercial Property Owners
By Burton Hancock – Cost Recovery Advisor
If you own commercial property you can increase your cash flow by reducing your taxable income using an IRS indorsed procedure called Cost Segregation.
What is cost segregation?
A cost segregation study is a strategic analysis that allows companies that have constructed, bought, expanded or remodeled real estate to increase their cash flow by accelerating depreciation[1]related tax
deductions. The analysis works most efficiently for new buildings under construction, but it can uncover retroactive deductions for older buildings as well. Cost segregation studies segregate and reclassify property costs currently being depreciated over the typical 39-year depreciable period to shorter depreciable periods of 15, 10, 7 or even 5 years. This means you can enjoy tax deductions right now that you’d otherwise have to wait years to receive. So you’ll not only increase the net value of current tax savings, but also boost your cash flow.
Who should consider a cost segregation study?
A cost segregation study may be a particularly wise move if you’re:
● Building a new facility
● Acquiring an existing building
● Improving, renovating or expanding an existing building
● Conducting leasehold improvements on your current facility
● Property cost was a minimum $650,000 (Land Excluded)
● You pay federal income taxes
● You intend to keep the building for at least 2 years
● The asset was placed in service after 1987
What properties can qualify?
● Assisted living facilities
● Auto dealerships
● Financial institutions
● Hotels
● Manufacturing facilities
● Multi-family residential facilities
● Medical offices
● Office buildings
● Restaurants
● Retail properties
● Shopping centers
● Warehouses
● Wineries
What are the typical savings you can expect from the study?
The average net present value (NPV) of additional cash flow is approximately $100,000 for every $1,000,000 of a 39 year property that is reclassified. Typically between 15% - 40% of a building’s overall
cost can be reclassified to one of the shorter cost recovery periods. The actual cash benefit depends on the type of property and its specific construction components.
Example: The Wall Street Journal reported an interesting example of a real estate developer in Southern California who used cost allocation accounting to his advantage, saving hundreds of thousands of dollars in taxes in the first year after performing the study. After developing a $4.6 million manufacturing facility, the owner could have depreciated the property by $120,000 using the simple 39 year straight line IRS formula. But by using cost allocation, the owner was able to depreciate the property by $397,000 in just the first year alone.
How some businesses have benefited
Manufacturing Firm
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5 year cash benefit
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$1,982,000
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Nursing Home
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5 year cash benefit
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$550,000
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Hotel Owner
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5 year cash benefit
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$376,000
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Office Building
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1st year cash benefit
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$275,000
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Auto Dealership
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5 year cash benefit
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$159,000
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Who can conduct a cost segregation study?
"Cost segregation studies require a skill and understanding of case law that is vested only in a specialist. The studies require a significant expenditure of time in preparation...Only those taxpayers with access to the professionals who can prepare a valid study may claim this tax benefit." Ken M. Berry, IRS
Until about 2004, cost segregation was only available to commercial property owners who were clients to the elite big 4 accounting firms. Most CPA's are aware of accelerated depreciation but do not have the architectural and structural engineering background to perform this very detailed extensive study that's needed to maximize the IRS Cash Benefit. This engineering[1]based study must be performed by a qualified engineering firm, or thousands and even hundreds of thousands of dollars could be left on the table. More importantly, if the report is not conducted by a qualified engineering firm it will not withstand an IRS Audit. Today, many CPA firms are partnering with cost segregation firms to bring this important accounting method to their clients.
How much does a cost segregation study cost?
Generally the fee for a cost segregation study is 10% to 20% of the resulting cash flow increase.
Whether you've purchased an existing facility or constructed a building from the ground up—owning real estate represents a significant investment for any business or investor. Cost segregation enables you to effectively frontload depreciation deductions into the early years of ownership enabling you to increase your cash flow, reduce your taxes and improve your ROI.
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