A Blog About Tax Savings for Building Owners
The global warming crowd continues to push hard on all aspects of society and it’s showing up now in commercial property. Washington DC is pushing to have all commercial development in the future be powered strictly by electricity. What could possibly go wrong? (Site will require you to create an account but there is no charge for the content).
Everyone thinks about buildings when they think about depreciation and the benefits of cost segregation, but don’t forget about the massive positive impact land improvements can on your depreciation. It’s common that land improvements might be anywhere from 4-15% of your overall building cost or basis. Sometimes we’ll even see 25%+! With 100% bonus depreciation, let’s say you have a $1 million building….if 10% of the building cost is land improvements, you could potentially take a $100,000 deduction in year one of your ownership! That right there would be about a $30,000+ tax savings – i.e. the money stays in your bank account and not the IRS’s.
The IRS classifies land improvements as 15 year class life property. Depending upon the type of property, we will regularly see such land improvements as:
Site improvements can have a BIG impact on your depreciation and provide a big depreciation expense for building owners when they apply a cost segregation study. Remember the cost segregation study will separate out your property from it all being lumped together as either 39 year (commercial) or 27.5 year (residential investment). Property will be reclassified to 5, 7, 15, and 27.5 / 39 year property. Right now for properties purchased / in-service as of Sept. 28, 2017 – December 31, 2022 can take 100% bonus depreciation. Bonus depreciation is available for property with class lives of less than 20 years…so all your 5, 7 and 15 year property could be depreciated in year 1 of your ownership. That can provide a significant tax savings for owners. Depending upon the building, you might be able to immediately depreciate 10-30% of the overall building cost or basis.
For those who want to grind harder on the topic, here’s the official link to the IRS on how to depreciation property. It’s a comprehensive list on all types of property and class lives. Otherwise, if you’d like to talk with me about seeing if your property might be a good fit for cost segregation, please don’t hesitate to reach out. My information is available under the Contact tab above or connect with me on LinkedIn.
As always, please consult with your own tax advisor for your specific situation to see if a cost segregation study might be beneficial to you.
Cost segregation works pretty much on all commercial buildings. If the building cost is north of $175,000 or so, there are tax savings being left on the table if the owner does not segregate the building in to 5, 7, 15, and 39 year class lives which is what happens when you do an engineering-based cost segregation study.
What might one see for results in such a study for a Panera Bread commercial building? Well, the owner might save about $100,000 on his/her income taxes by doing a study. The cost of the study would be a small fraction of the overall savings.
Let’s say in this scenario we have the following:
Building Cost: $1,500,000
Increased Accumulated Depreciation: $310,000
Estimated Tax Savings @32% Federal Rate: $99,200
The building owner doesn’t have to write a check to the IRS for that $99,200. The money stays in his/her bank account and they can do with it as they see fit….remodel bathrooms, buy a new building, buy a new car, pay off debt, increase wages for employees, buy a short term rental, take some vacations….they money is there’s and remains with them. I don’t care how much money people have…they could have millions, but there hasn’t been a single person yet that I’ve come across who says they aren’t interested in keeping an extra $100,000. And it doesn’t have to be $100,000….we run scenarios for all kinds of property…let’s say you own a building that is only $300,000 but by doing an engineering-based cost segregation study, you might be able to save $15,000-$20,000 on your taxes. That’s real money and people would rather keep that money in their bank accounts rather than the IRS’s.
Note, the numbers above are estimated tax savings. Each study is different and we wouldn’t know the final results until the actual study is completed. A building owner’s tax situation and tax rate might be different. If they were in the 37% tax bracket their tax savings would be quite a bit higher. If they are in a lower bracket then the savings would be lower. As always, I can’t give tax advice. When considering cost segregation, get an estimate and then discuss it with your own tax professional to see if you can benefit from doing a study.
Commercial brokers play a very important role in the ongoing development and improvement of a community. They are often in-the-know of what’s happening in a particular area…who’s developing what and which companies are moving in and/or expanding. They help business owners, building owners and investors of all kinds with sourcing or developing a building or project to suit the prospective owner’s needs. They often can help give recommendations on financing, inspections, engineering, surveying, insurance, renovations, construction etc. The one area they are weak in is in cost segregation.
Why should commercial brokers have a trusted source for cost segregation amongst their mix of other expert advisers whom they can readily share with a prospective client? It’s pretty simple….commercial brokers should introduce cost segregation to every client and have each building evaluated. There’s no cost to do this and the upside is significant certainly for the client. The commercial broker can also generate another income stream for his brokerage by partnering with us to deliver this service to his clients.
We know the upside for the client on cost segregation but why wouldn’t the commercial broker also participate in creating another revenue stream? Ask me about our referral program. It can help pay for some office lunches, outings and year end parties. But the bigger thing is that the broker will have helped his client maximize his/her building by saving a lot of money on taxes. The tax savings provided to the client might actually be enough to help that building owner go buy another building of which the broker may represent him/her on that and make another commission.
Remember, not every building or every building owner is going to need to actually do a cost segregation study. Some buildings aren’t profitable and maybe won’t be for some time. Some owners aren’t particularly profitable either and so they don’t need the tax deductions. However, every building should be evaluated so you at least have it on hand and can reference it each year as you review your particular tax situation for that year. Perhaps you don’t do cost segregation for a variety of reasons in 2022…maybe not even in 2023. But by 2024, it probably makes more sense. Well, a smart business owner, building owner and investor is going to know what that might look like for him or her. There’s no reason they should not have an estimate on hand and in their files. It should be part of a normal business and tax review process if not quarterly…at least annually.
Cost segregation will save big money for most owners. They might see between $30,000 – $70,000 in income tax savings per $1 million in building cost or basis. We can do studies on buildings with a cost or basis as low as about $175,000.
Lastly, I will say that as I speak with building owners, 8 or 9 out of 10 have not heard of cost segregation. Of those that might be familiar with it, there’s a lot of misperceptions as to it’s value vs. it’s cost. It’s very common for me to quote estimates that demonstrate a 10, 15, 20:1 return on their investment in the study. That’s a 1,000 – 2,000% return. Most commercial real estate delivers returns in the 5-8% range…we’re talking massive returns here with cost segregation compared to the investment in the study. The most likely way a building owner would hear about cost segregation would be through the commercial real estate broker. Please share the information…make an introduction and let’s help building owners maximize their buildings, lower their taxes and increase their cash flow.
Be sure to reach out and I’d love to help – John Murphy, 864-276-1448
It’s always a good day when I can deliver our engineering-based cost segregation study to a building owner to helpl him/her save money on their taxes. Remember, what we do is reclassify a building from 39 year straight line depreciation in to 5, 15 and 39 year class lives. This allows the owner to take a bigger depreciation expense earlier in the life of his/her ownership of the building. That translates in to paying lower income taxes…and in some cases, it eliminates your income tax liability for a while.
This was a gorgeous older building in Spartanburg. It goes by the name Warrior Duck. It’s a 3 floor office building. As you can see by the image above, we saved this owner nearly $90,000 in income taxes.
As with all of my articles, I am not given tax advise. Everyone’s tax situation is different and each building performs differently. Please consult with your own tax counsel when considering cost segregation.
Blake Alguire is a commercial real estate agent in the Upstate of South Carolina. He interviewed me recently about cost segregation for building owners and how they can save money on their taxes. It’s a short but informative 15 minute interview. It was a lot of fun to catch up with Blake! #costsegregation #taxsavings #buildingowners #commercialrealestate #realestateinvestors #shorttermrentals #commercialproperty #commercialbrokers
Most people think of utilizing cost segregation when it comes time to settle up their taxes owed at the end of the year. Because of that, we are very busy as you can imagine leading up to March 15th for corporate returns, April 15th for personal returns and then with extensions it’s September 15th and October 15th, respectively. But did you know that you could use a cost segregation study…even an estimate to help offset your taxes owed for your quarterlies?
The September 15th quarterlies are due next week and many business and building owners will be writing checks to the IRS. At the same time most of these owners are likely sitting on untapped depreciation that they could use to offset this tax obligation. How so? At this point there isn’t time to get an engineering-based cost segregation study completed. Those tax a solid six weeks. However, an owner could reach out to me and get an estimate for his/her building to see what kind of tax savings might be available should he go forward with a cost segregation study.
Let’s say you own a million dollar commercial building and you’ve had it for a couple of years. Or maybe you own a rental home, a duplex, a small apartment…it doesn’t matter really. If you own an income producing residential investment or commercial property may be able to apply this strategy as well. Please run this past your own personal tax advisor.
Let’s take that $1 million commercial building that you’ve owned for 3 years. You’ve taken a small amount of depreciation straight line. But if you were to segregate out the 5 year and 15 year class life property, you might be able to take 15-20% of the building’s basis this year and lower your tax bill. On a building like that it mean a tax savings of $50-$75,000. Let’s say you owe $15,000 for your September 15th quarterly tax payment but you have a cost segregation estimate from us showing that if you do a study, we’ll save you $50,000 on your income taxes. Well you know have that as your documentation, should it ever be needed, that you don’t owe any quarterly taxes September 15th. Oh, and the study would cost you a lot less than that $15,000 tax bill BTW.
As we anything I publish, this is not tax advise but merely a strategy some building owners use to help offset their tax liability. Please consult with your own tax advisor on any and all tax decisions including possibly utilizing a cost segregation study.
There are thousands of these kinds of stores across the U.S. Starbucks is opening more stores than McDonalds and Subway combined. In 2022, it looks like they may be on pace to open about 2,000 of them around the world with half of them in the U.S. roughly. I see sales of these buildings highlighting that they are NNN – triple net lease – with Starbucks as the tenant. It seems almost like a no brainer for some investors who fit a certain profile on their return needs and risk appetitive – or lack thereof.
But are these buildings good candidates for cost segregation? Absolutely they are! First of all while they can be a bit sparse on the inside, the finishing that they do have is quite nice. That’s where you’ll pick up your 5 year class life property. Then they often have good-sized parking lots, sidewalks, maybe an outdoor patio, lighting etc. That’s all going to be 15 year class life property and it will be significant.
I see a lot of these properties come across my LinkedIn stream with many of them now priced at about $2MM to $2.5MM. They are often placed in locations with high visibility and traffic so the land values are high. But normally we see the building basis on these once we deduct the land value come in at $1.4-$1.8MM. For ease of our discussion, let’s call it $1.5MM. What’s your tax savings?
Estimated Increased Accumulated Depreciation:
5 Year Class Life Property: 14% or $210,000
15 Year Class Life Property: 7% or $105,000
Total reclassified property eligible for 100% Bonus Deprecation: $315,000
Estimated Tax Savings at 32% tax rate: $100,800
Ballpark cost on a building like this might be around $6k +/- giving you a 25:1 return….that’s 2,500% return on your investment in the study.
Does cost segregation work for Starbucks buildings? I would say so!
Does cost segregation work for restaurant buildings? It absolutely does! The U.S. is filled with buildings like the one above for TGI Fridays. I’m just using this as an example.
Restaurant buildings typically are owned by someone else and not the restaurant owner. If they are owned by the restaurant owner, then that owner might consider grouping his/her real estate entity with the restaurant operating entity to take advantage of the tax savings with cost segregation. To make the designation to “group” those entities, it must be done in the first year you file taxes for the building. Here’s a helpful article about grouping for business owners.
Most restaurants have nicely finished interiors as well as lots of parking. Both are key to taking advantage of the tax savings available through cost segregation. A lot of the internal finishing is going to be reclassified as 5 year class life property. The parking lot, landscaping and overall site improvements will be classified as 15 year class life property. For buildings purchased between September 28, 2017 up until December 31, 2022, the owners can take 100% bonus depeciation on all property with a class life less than 20 years. So obviously all that 5 and 15 year property can be 100% bonus.
What do the numbers look like? Let’s run the following scenario. Let’s say the restaurant was purchased in July 2022 for $1,850,000. The land might be valued at $400,000. So the amount of building basis to be studied is $1,450,000. Of the $1.45MM property, it may be reclassified as follows: (note…these are just estimates based upon experience…each building may have a higher or lower % of the various class lives):
5 year property: 18% / 261,000
15 year property: 8% / 116,000
Total Accumulated Depreciation Expense: 377,000
Tax Savings at 32% Federal Tax Rate: $120,640
Cost: $5,500 – $6,500
Net Cost After Tax: $4,080 (if study is $6k)
ROI: 30:1 —> that’s 3,000% return by the way
BTW, if the owner continues to take just straight line depreciation 1/39th each year, that equates to about 2.5% of the building basis or approximately $36,250 each year. It would take more than 10 years for this owner to get the depreciation on this building that he/she could take with just one year doing cost segregation.
It’s nearly 90% of the owners I speak with have no idea of the tax savings available to them. Their commercial brokers are bringing it up. Their CPAs aren’t bringing it up. So I’m trying to get the word out to help these business / building owners maximize their buildings, reduce their tax burden and drive greater cashflow. It’s not a bad gig.
This does not constitute tax advice. I’m just showing what we might be able to do for this type of building. I recommend that you discuss cost segregation and your particular tax situation with your CPA or tax professional.
Businesses depreciate capital assets and buildings which is all part of standard accounting. I found this article on depreciation methods to be particularly helpful when trying to understanding the different methods of calculating accelerated depreciation. This is more from the perspective of capital assets for a business. The article looks at double declining depreciation method as well as the sum of the year’s digits methods.
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