Dental buildings have really come a long way. We are seeing more and more of them with beautiful design and finishing. Many now cost between $1.5 – $2.0 million. That’s a big expense for anyone and especially for dentists who may well be continuing to pay for dental school loans.
If the ownership of the operating business and the LLC that owns the dental building are the same, the dentist can group these entities the first year they put the building into service. That allows the operating LLC to take advantage of the depreciation generated by the real estate LLC. The tax savings can be significant.
Many of these buildings will see 20-30% of the building cost or basis able to be depreciated in the first year. For buildings placed into service starting in 2023, the bonus depreciation drops from 100% to 80% so please note that.
Recently we saved this dentist well over $100,000 on their income taxes when we did an engineering-based cost segregation study for them.
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
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
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.
