Commercial building owners can use a cost segregation study results to eliminate or minimize their quarterly tax payments. These building owners can even just use an estimate or predictive analysis from a qualified cost segregation firm an apply that to the calculations for what their tax liability might be for their quarterlies.
As I write this today, the September 15th deadline is coming up late this week. As building owners and their CPAs make the final calculations for what the owner’s estimated tax bill might be, we can generate an estimate for that owner yet this week that would impact what that owner owes for his quarterly payment.
For example, let’s stay a business owner / building owner is expecting that he or she has to write a check to the IRS for $20,000 for his quarterly payment. This owner also owns a building that he has owned for a few years but has never done a cost segregation study. We can run an estimate this week and provide an idea what that owner might save on his taxes. Let’s say the estimate comes back and we believe he may save $30,000 on his income taxes if he applied it to this year’s tax return. If that’s the case, that $20,000 that he owes this week could stay in his checking account rather than being sent off to the IRS.
Please consult your own tax advisor. This post is not tax advice. Please reach out to me if you’d like for me to run an estimate on your building.
Photo: Environmental and Energy Study Institute – ESSI
Cost segregation is a tax strategy used by commercial building owners to accelerate depreciation deductions on certain building components, such as electrical systems, plumbing, and HVAC systems. While cost segregation can provide financial benefits in the form of reduced tax liabilities, it may indirectly contribute to climate change mitigation efforts in a few ways:
Incentivizing Energy-Efficient Upgrades: Cost segregation can free up capital for building owners by providing immediate tax benefits. This additional capital can be reinvested in the property to make energy-efficient upgrades, such as installing energy-efficient lighting, insulation, windows, or HVAC systems. These improvements can help reduce a building’s energy consumption and carbon footprint.
Supporting Renewable Energy Investments: Building owners who benefit from cost segregation may choose to invest in renewable energy systems like solar panels or wind turbines. These investments can reduce a building’s reliance on fossil fuels and decrease greenhouse gas emissions.
Encouraging Sustainable Practices: As commercial building owners become more conscious of the environmental impact of their properties, they may be more inclined to adopt sustainable practices, such as recycling, waste reduction, and water conservation, in an effort to further reduce their carbon footprint.
Promoting LEED Certification: Cost segregation can help free up funds that can be used to pursue Leadership in Energy and Environmental Design (LEED) certification or other green building certifications. Achieving these certifications often requires investments in energy-efficient building designs and technologies, which can lead to reduced energy consumption and environmental benefits.
It’s important to note that while cost segregation can indirectly support climate change mitigation efforts, its primary purpose is to optimize tax benefits for building owners. The extent to which cost segregation contributes to environmental sustainability will depend on the specific choices made by the building owner and the extent to which they prioritize sustainability in their investment decisions.
Additionally, tax laws and incentives related to energy-efficient building improvements and renewable energy systems may change over time, so it’s essential for building owners to stay informed about current regulations and consult with tax professionals to make informed decisions regarding cost segregation and its environmental implications.
If you’re looking for more details on how you can make your commercial buildings more environmentally friendly, ESSI has some excellent information.
What kinds of properties are good for cost segregation? I get asked this a lot especially as I introduce the concept of cost segregation to commercial real estate brokers. The fact of the matter is, cost segregation works on any and all properties where the owner is receiving a rent or lease payment. With the firm I represent, we generally add one more qualifier and say that the basis or cost needs to be about $200,000 for it to make sense to study. And the reason for that is the minimum study will cost about $2,000 and if you have a $200,000 building – maybe an SFR – you might see a depreciation expense of $30,000 – $40,000. If you’re at the 24% income tax rate, that’s a tax savings of $7,200 or so. Sometimes we still do studies down to about $150,000 in cost basis and it’s still a benefit for the owner.
Cost segregation works on all kinds of property:
Industrial
Manufacturing
Warehouse
Office Warehouse
Self Storage
Cold Storage
Office
Retail Strip Centers
Strip Malls
Restaurants
Fast Food Restaurants
Auto Repair Shops
Hotels / Motels
Apartment Buildings
Rental property – SFRs, Condos, Townhouses
Short-term rentals – Aibnb, VRBO
Gyms, Athletic and Fitness Centers
Determining if cost segregation is right for you is a fairly straight forward endeavor. You will always want to consult with your tax advisor about your particular situation. It really just becomes a math issue. You get an estimate from me and then discuss with your tax advisor. Does it make economic sense or not. It’s also not as expensive as you might have been led to believe. For most of our clients it is not a big set back and they typically see 10-20x return on the investment with us. That’s 1,000 – 2,000% return on your investment. It’s generally a no-brainer.
Short-term rental ownership exploded during Covid. The business model has been a good one for many investors throughout the country. These property owners can take advantage of cost segregation just like they would if they owned a commercial building or an apartment complex.
Short-term rentals, VRBOs, Airbnbs are considered 39 year property. It’s commercial property like a hotel is commercial property. It’s not 27.5 year property which is what a long-term rental would be such as a single family rental or an apartment building.
Is it worth is to doing cost segregation on an STR? Yes, of course. Where it might not be beneficial is if you just aren’t netting much profit or if you expect to sell your property within the next year or two. But generally, from what I hear, owners will net $25,000 – $50,000 per year.
In a cost segregation study, the property will be reclassified from all of it being 39 year depreciation to 5, 7, 15 and 39 year property giving you a much bigger deduction earlier on in the life of your ownership. Let’s use simple math to make some calculations. Let’s say you own an Airbnb and you have $600,000 all in. The land is about $100,000. That leaves you with $500,000 cost basis. Normally the FF&E is a separate expense from the real estate. In this case we figure you have this as a separate line item of $35,000 and it is not included in the real estate.
When we do a study on a building like this, we will generally see about 15-20% will be reclassified as 5 year class life property. The land improvements which are 15 year class life property will often come in somewhere in the 3-10% range depending upon the property. So for simple math, let’s say we identify 20% between the 5 and 15 year property. 20% of $500,000 is $100,000. You would get a $100,000 deduction against your income in year one or whenever you decide to do the study and apply it. Now in 2023, bonus depreciation has dropped to 80%. (If you own an STR that you placed into service between Sept. 27, 2017 and Dec. 31, 2022, you would qualify for 100% bonus depreciation). So that $100,000 in depreciation generated by our study would have 80% of that applied to reduce your taxes in 2023. Let’s say you net $50,000 in 2023. That’s after all your expenses, debt service and regular straight line depreciation. If you’re at the 32% tax rate, you’d owe the IRS $16,000. If you did cost segregation, you would owe ZERO and would have a loss carry forward that would eliminate most, if not all, of next year’s tax liability. The cost for such a study might be $3-4k. If you have owned the property for at least one tax year, you would need to file a 3115. That will end up costing you about another $1-2k to complete.
So if you own a short-term rental property and are making money, be sure to reach out to get a quote and see how it might work for you.
