Cost Segregation Explained for Mobile Home and RV Park owners in 2 minutes. These are great assets for cash flow and the depreciation these parks generates is second only to C-stores and tunnel car washes. It’s not uncommon to see 50-90% of the property get reclassified so it can be accelerated.
What does this mean? Let’s say you purchased an RV Park for $2.5MM and the land is worth $500,000. That leaves you with a cost of $2MM which as it sits is 27.5 year property. But what if you could reclassify 75% of it by doing cost segregation? That’s $1.5MM in property that has been reclassified as either 5 or 15 year property. In 2023 you can take 80% bonus depreciation. So the owner could get a depreciation expense of $1.2MM in year one of owning the property. If he/she took straightline 27.5 year deprecation without cost segregation, the depreciation expense would be a maximum of about $72,000 that first year depending upon when they put it into service.
Remember that cost segregation is based upon cost and not appraised value. If you have a property that you paid $200,000 for 20 years ago and now it’s worth $1.5MM, a study isn’t going to help you much unless you’ve done a ton of improvements along the way. What we are seeing is a number of these parks are either being developed or they are trading hands. Once that happens, the new owners should definitely look at doing cost segregation.
I work all over the U.S. in all 50 states and get calls from all over the place to help with cost segregation not only on these assets but all types of commercial property. I’d be happy to talk with you at no charge and if you’d like our team to run the numbers for you, just let me know. Connect with me on LinkedIn or Twitter.
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.
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.
Why doctors, dentists and lawyers should consider utilizing cost segregation with their real estate investments to save money on their income taxes.
I do a lot of work with doctors, dentists and lawyers when it comes to cost segregation. For nearly all of them, it’s a passive income investment. There are times though when they own the building(s) that they run their operating business out of – i.e. self rental. At that point they often can take advantage of “grouping.”In that case, cost segregation is a grand slam as they can use the depreciation from their real estate to offset their operating business income.It’s massive. Sometimes I run into situations where the doctor, dentist or lawyer or some other high income W-2 earner own a short-term rental like an Airbnb or VRBO and their spouse is running the operation. At that point they might also be able to utilize the depreciation generated from cost segregation to offset their high W-2 income. (BTW, as with all of these things…this is not tax advice. Please consult your own tax advisor regarding these strategies). I will publish information in a future blog post about high W-2 earners owning and operating short-term rentals.
But let’s get back to owning real estate as a passive income investment for these highly compensated professionals. If they own residential real estate investments (rental homes, duplexes, triplexes, quads, apartments etc) or if they own commercial real estate of any kind and IF they earn a profit at the end of the year, they will owe federal income taxes at their marginal rate. More often than not that rate is 32, 35, or 37%.
Let’s say they own a few buildings and when all is said and done, at the end of the year, they have a net profit of $10,000. They expect their investment to grow in future years if not through the purchase of additional units or buildings, then through rent growth. The $10,000 in net profit is after all expenses, debt service and normal straight line depreciation. If they pay taxes at a 35% rate, they would owe the IRS $3,500 for the year. Next year it would likely be more as their net profit grows. A cost segregation study would eliminate this $3,500 tax obligation for the year and would likely wipe out future income tax liabilities on their real estate investments for years to come. How could this be you ask? The magic of increased accumulated depreciation expense / i.e. bonus depreciation or accelerated depreciation creating a large loss carryforward.
Let’s say in the scenario above, one of the properties you own is a $500,000 duplex and the land is worth $100,000 which is not depreciable. So $400,000 is your cost / basis that can be depreciated. A cost segregation study will identify and separate the 5, 15 and 27.5 year property. Often this might be between 20-25% of the building cost or basis. Given that information, you will likely see an $80,000 – $100,000 depreciation expense. If you purchased the building and put it into service between Sept. 27, 2017 and Dec. 31, 2022, it qualifies for 100% bonus depreciation meaning you can take all of that $80-$100k in depreciation in one year. (At this point bonus depreciation starts to phase out – for buildings put into servince in 2023, they will qualify for 80% bonus depreciation…in 2024 it goes to 60% etc). So let’s say it’s $80,000 in depreciation. You had a $10,000 net profit and were going to owe $3,500 to the IRS that year and likely every year going forward. By doing the study, you would not have any taxes owed this year. You’d have a $70,000 loss carry forward which you would utilize in future years. In this scenario, you may have eliminated your tax liability for the next 6-7 years. A cost segregation study for a building like this might cost $3,500 or so. You might also have to file an IRS Change of Accounting Form 3115. (If you’ve owned the property for at least one tax year, you will have to file this form). The 3115 let’s the IRS know you’re going from straight line to accelerated depreciation. We draft those typically for about $750 and your tax advisor would sign off on it.
Let’s review…you have $4,250 into the study and 3115 draft. (You’ll probably have some additional fees from your tax advisor as they have to fill out the 3115 information document so we can draft that form). So maybe your tax advisor is going to charge you another $500. So you’re all in at about $4,750 +/-. That’s a business write off for you so it’s really costing you a net of $3,087.50 roughly. That’s less than what you were originally going to have to pay the IRS when we started. The $80,000 in depreciation expense that you’ll get, ends up saving you about $28,000 in federal income taxes ($80,000 x. .35). That’s a 9 to 1 return or 900% return on your investment. You likely wiped out your tax liability for years to come and you can use that money to reinvest, put in the bank, take a trip etc. It’s your money. You can do with it what you want.
If you’d like to learn more or get a quote for your building, please just reach out and I’d be happy to discuss. We alway recommend you also talk with your tax advisor. Once you get a quote from us, please have your tax professional review it to make sure they are on board and that you can in fact utilize the depreciation expense we generate with cost segregation.
Now that we are well beyond the difficulties of the Covid-19 pandemic, hotel brands are once again starting to push on the hotel owners to make improvements to their buildings. Are the PIPs (property improvement plans) still in place? Since many hotels didn’t have many customers for a while during the long duration of the pandemic, their furnishings as well as other items such as carpets and bathrooms may not have seen the wear and tear that they would have. Consequently, plans to change those out have been pushed out. But the time is soon coming to make those improvements.
This is also a reminder that when hotels are doing these renovations that they should also be looking at doing a partial asset disposition study (PAD). These are done when the renovations are more than $100,000 which nearly every renovation of a hotel will certainly hit. Partial asset disposition allows for the owner to take a tax deduction in the year in which the renovation was done. It’s a use it or lose it tax deduction. Since you are putting new material into your building and throwing out the old, we do the calculations as to what you are throwing out. There is basis that is still on your books and with our study, you can deduct that off your books since you’ve removed it from the building. Not only do you get a tax deduction but since it’s off your books, you don’t have to pay recapture tax on it when you go to sell the building.
Every project varies depending upon the kind of work done and how long you’ve own the building, but it’s reasonable to expect that you might see a tax deduction of 15-20% of the improvement amount. So for example, let’s stay you are planning a $500,000 improvement. By studying that work effort and doing a partial asset disposition, PAD, you might see a $75,000 – $100,000 +/- deduction that year on your taxes. If you are paying 32% Federal tax rate, that’s $24,000 – $32,000 in tax savings. These studies tend not to cost much. If you have already done a cost segregation study on your building then this might only cost you another $3,000 – $5,000 to do. That cost is an expense of course. If you need to do cost segregation, that will increase the overall cost for as you’ll have to do a cost segregation study but a cost seg study will likely yield another massive tax deduction for you in addition to what is noted above.
If you own a hotel and you are planning to do renovations and would like to discuss, please give me a call. If you did renovations in 2022 and have filed an extended tax return, there is still time to do a partial asset disposition and take advantage of this great tax deduction. Once you’ve filed your taxes for the year in which the work was done, you cannot amend to go back and take this deduction. It truly is use it or lose it. Most lose it because they are not aware of this. I work all over the U.S. and can help you on a project anywhere in all 50 states in the U.S. John Murphy 864-276-1448.
Recently I received a call from someone inquiring as to whether or not Starbucks were good for cost segregation. Yes, they are excellent for cost segregation because they typically have large parking lots (15 year land improvements) and excellent interior finishing which a lot of that ends up being identified as 5 year class life property.
Here’s a good example. Let’s say this Starbucks was purchased for $2.5 million and the land was worth $500,000. Since the land cannot be depreciated, that must be deducted so we come up with a basis of $2,000,000 for the building. Every building is different but for the sake of understanding how cost segregation can help an owner of a Starbucks building let’s look at how this breaks down.
A cost segregation study is going to identify and reclassify all the building components as well as segregate the land improvements. So with this property, let’s stay 17% was identified at 5 year class life property. That would be $340,000. And for the land improvements, let’s say those come in at 20% which would be $400,000. So on a $2 million building, this owner could accelerated $740,000 or 37% of the building cost or basis. Depending upon the year in which this went into service, it could be taken as 100% bonus depreciation (Sept. 27, 2017 – Dec. 31, 2022). If the building went into service in 2023 then it would qualify for 80% bonus depreciation. (Bonus depreciation drops 20% each year until 2027 when it goes to zero or just regular accelerated depreciation).
If the owner is paying federal taxes at say a 35% rate, that would be a tax savings of almost $260,000 in income taxes. These studies would typically cost less than $6,000 which is an expense…so it’s a net of $3,900. That’s an ROI of about 66:1.
If you’d like to have us evaluate your property for cost segregation, please feel free to reach out and I’d be happy to discuss.
We all know that mobile home parks and RV parks kick off tremendous cash flow for the owners. It’s a phenomenal real estate investment. There are many different groups of investors who have been trying to buy as many of these parks as they can get funds to do so. In part what they do is they buy these and then immediately cost seg them for massive income tax savings.
If you’re reading this blog post you probably already have a pretty good idea about cost segregation, but in case you don’t, cost segregation is a tax planning strategy where the owner segregates or reclassifies real property into shorter class lives. This allows the owner to take a bigger tax deduction earlier in the ownership of the property.
Mobile home parks and RV parks are some of the best assets for cost segregation. I will often get asked…”how might a specific property do with cost segregation?” I can usually give them a ballpark figure and then have our team run an estimate but other than C-stores and tunnel car washes, there isn’t another asset class that performs as well with cost segregation as does a mobile home park or RV park.
It’s very common for us to see 50-70% of the overall cost be able to be accelerated – i.e. depreciated in the first year of ownership. Let’s say you buy a mobile home park for $2.5 million. The land is worth $750,000. That leaves $1.75 million in cost basis. We would run an estimate for you and note that you could expect $800,000 – $900,000 in increase accumulated depreciation expense. But the actual results might reach as high at $1.5 or $1.6 million potentially. Of course we would not know that until we completed the study. So what happens in these situations is many times these owners have other parks that kick off massive cash. They have big tax liabilities because of that. But now they buy this new park, cost seg it and get maybe a $1 million tax deduction in that first year of buying the new mobile home park. They don’t need that $1 million to offset the income from this newly acquired park but they do need it to offset the other income from their other parks and properties. A cost segregation study like this might cost somewhere in the neighborhood of $5,000 – $7,000 depending upon the complexity of the property.
What kinds of property can be accelerated? Below is an example of what you might see in a cost segregation study for a mobile home park. In this particular study, the owner would be able to accelerate $2,141,369.70. At a 37% federal income tax rate, that would be an income tax savings of $792,306. I don’t know what this study cost but let’s say it was $6,500 which is a business write off. That $6,500 after tax is $4,095 making the ROI 193:1….that’s 19000% return on investment. Crazy but it’s legit.
If you’d like to learn more about cost segregation or would like us to run an estimate for you, please reach out. We are happy to run numbers for anyone no matter where you are. There is no charge and no obligation. I can study properties anywhere in the United States and am happy to help.
Property and casualty insurance agents and brokers could offer even greater value and service to their commercial lines clients if they offered cost segregation services.
P&C agents and brokers are talking with commercial building owners on a regular basis about their insurance needs. Inevitably their client base owns commercial buildings and perhaps some multi-family, short-term rentals and rental homes. It’s an easy conversation to have with a business owner whom you know owns a building because you are either insuring it or you are hoping to win his business and insure it going forward. As part of that conversation, why not ask, “BTW, have you done cost segregation on your building for tax savings?” That’s it. If they have done it, great, but if the response is like what I find about 8 out of 10 times the owner hasn’t and he knows little to nothing about it. It’s then just a matter of, we’ll have our guy run an estimate for you and you can then run it past your tax advisor to see if this might be something you can utlize. On average, building owners save between $30,000 – $70,000 per $1 million in basis or building costs.
You can then reach out to me with the specifics on the building because you likely have it in your database already. Many times I can look up most buildings, but we need the following:
Address
Building type
Date of Purchase or In-Service Date
Purchase Price
Land Value (est)
Improvements – year / type
Within a day or two, we will turn around a custom estimate for this owner to save on his/her income taxes. Many times the building owners will see a return something in the neighborhood of 10x what they will invest in the study. Meaning, let’s say the study costs $5,000. The owner’s tax rate is 32%. His net cost after tax would be $3,400. If he saves $50,000 on his income taxes, that’s an ROI of 14:1 or 1,400% return on his investment in the study.
As a property and casualty insurance agent or broker, we’ll do a revenue share of 10% on our study fees. That $5,000 study will generate $500 for your agency. This would likely be for a $1-$1.5MM building. Smaller buildings have smaller fees. Bigger buildings would have bigger fees. How many buildings does your agency insure? If my experience is that about 8 out of 10 are unware of this tax application, don’t you see how you could be a big help to these building owners to help them save on taxes, increase cash flow and maybe help them stay in business?
Lastly, I have heard that insurance premiums for commercial lines have gone up 15-25% in the past year. What if you had a solution to help that business owner when you call him to discuss his renewal for the upcoming year and you’re concerned about possibly losing a client because his rates are going to jump by thousands of dollars. Well, this might be a solution. He might have a building or two that he has not done a cost segregation study on that might generate lots of tax savings which could afford him the cash flow to more easily pay for the increased insurance premium.
And when your agents are on the phone prospecting talking about insurance, this is a another way to try to engage the building owner. Who knows…maybe he’s not ready to buy insurance from you just yet but he does cost segregation because you introduced it to him. Perhaps that will engender some favortism toward you when he does go to re-evaluate or renew his insurance coverages in the coming year.
Cost segregation is a terrific value-add service for property and casualty agents and brokers. It’s a great way to help your clients and to differentiate yourself from the competition. On top of that, it’s an additional revenue opportunity for the agent and agency. Reach out if you’d like to discuss. I work all across the U.S. in all 50 states. One does not need to be licensed to offer cost segregation. John Murphy 864-276-1448.
The views expressed are my own. I do not speak or write in any official capacity for the firm I represent for cost segregation – Cost Segregation Services, Inc.
Here is a strategy I’m seeing for married couples where one spouse has a big W-2 income.
Please consult with your own tax advisor. I cannot give tax advice. I’m only sharing what I’m seeing some other real estate investors do.
Want to take advantage of cost segregation and minimize your taxes but you’re not a full time real estate pro or investor? Perhaps you’re a doctor, executive, a sales pro who has a big W-2 income who wants to get into real estate investing. Some who fit this category are purchasing STRs (Airbnbs, VRBOs) and managing them themselves. Generally speaking this would require that one’s spouse does the managing and not the person with the big W-2 income. The IRS categorizes the STRs differently from long term rentals (i.e. single family rentals, duplexes, apartments etc). The STR is considered an active trade or business. If you meet the IRS criteria as being actively involved in the property, you may be able to utilize the benefits of cost segregation and the large depreciation expense it generates to offset tax liability for the W-2 income. BTW, you don’t have to be making multiple six figures to make this work. This strategy could work for someone making less money. When I see it used, it’s often the big W-2 income earners who are doing this.
I was recently at an event where a CPA explained this strategy to a room full of real estate investors. It was discussed that they might consider converting a rental home to an STR to be able to take advantage of this.
Let’s say you buy an Airbnb for $425,000 – purchase price plus any improvements, furniture etc. The land is worth 20% ($85,000). That is deducted that since land can’t be depreciated which leaves a cost or basis of $340,000 which can be cost segregated. Depending upon the property, the study results would likely show that 20-25% of the $340,000 basis could be accelerated. That is $70,000 +/- in depreciation expense that could be used to lower you and your spouse’s overall income by $70k. If your tax rate is 32%, that’s over $20,000 in income tax savings. The study might cost $2,500 +/- which is a deduction. This is a 10x return – 1,000% return on your investment. If you were to scale this up to say $1,000,000+ Airbnb, just multiply these tax savings by 2-3x and you can see why people do this.
If you are one of those couples who has a big income and wants to use real estate to help reduce your tax liability but neither of you are a full time real estate pro, then discuss this strategy with your tax advisor. If you fit this description and you have a short-term rental, reach out to me for a no cost, no obligation estimate. You’ll then have solid information to go back to your tax advisor to determine if doing a cost segregation study might end up saving you a small fortune on your income taxes.
