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
Category: Cost Segregation (Page 4 of 4)
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.
This question comes up a lot. Normally the best time to do a study is right at the time of purchase or when it is placed in service. It will allow the owner to maximize the accelerated depreciation available to him/her. Having a cost segregation study done that includes the defining of the key building systems will prove helpful for building owners to stay in compliance with the Tangible Property Regulations that went in to effect in 2014. But the truth is an owner can do it almost at any point in time of their ownership. You will want to get an estimate and if you’ve owned the building for some time, we’ll need to review your depreciation schedule to see if there is any an opportunity for you to benefit from accelerated or catch up depreciation. Remember, most building owners see an income tax savings of between $30,000 – $70,000 per $1 million in building costs (basis).
If you end up waiting a year or more from the time you purchased the property or put it in to service, you will have to file an IRS form 3115. It’s a change of accounting form that gets used for a lot of purposes. It gets filed all the time so there’s no worry to think just because one of these needs to be filed that you’ll open yourself up for audit. We have not seen that to be the case. The form is a bit complicated. The firm I represent will produce a draft of the 3115 and calculate the negative 481a adustment for $750 and then the building owner’s CPA would sign off on it. If the CPA won’t sign off, then we will for another $500. Most CPAs like the fact that we take care of the 3115. This isn’t a huge expense but it does add to the overall cost of a study. Let’s say your study costs are $4-$5k. The 3115 is going to add about 15-20% to the overall cost. Again, not a big deal but you just need to be aware of this.
What if you can’t use all the accelerated depreciation in the year you have the study done? Well, you can carry the loss forward and put that to use unlil that loss is consumed. I have seen many times where owners don’t have to pay income taxes on their property income for 2, 3, 4+ years or more sometimes because of the accumulated accelerated depreciation that was generated from a cost segregation study. I cannot give tax advise. I’m just sharing what we’ve seen other building owners and investors do. Please consult with your tax advisor when considering doing a cost segregation study and whether or not you can benefit from it.
Want to talk about it? Reach out and I’m happy to have a discussion and can provide you with an estimate.