Are you maximizing your tax deductions?
Many commercial real estate investors are not maximizing the tax depreciation deductions from their assets, foregoing a potential savings of hundreds of thousands of dollars. If you own commercial real estate, there are likely many assets that you are depreciating over a much longer period than required. Unless you have done a cost segregation study, it is unlikely that you have optimally classified all of your assets for your investment.
A cost segregation study identifies specific assets that can be reclassified from "real property" into "tangible personal property." It goes beyond the easy-to-identify items such as furniture, fixtures and equipment. Some examples of property and improvements that get misclassified are carpeting, wall coverings, cabinetry, specialty lighting, specialty electric and plumbing, asphalt, concrete, signage and landscaping. While this is not a new strategy, it is not widely understood and it is underutilized.
Many expenses that would typically be depreciated over 39 years are identified in a cost segregation study and reclassified into shorter life classes that qualify for five-, seven- or 15-year write-off periods based on tax regulations. Having these larger write-offs will lower taxes and increase cash flow.
"Cost segregation studies are quite complex and almost every commercial real estate owner will need a seasoned tax accountant to complete the study accurately," said Jack Rose, Chief Strategist at Breakwater Equity Partners. "In most cases we have found that the study is an absolutely worthwhile exercise; we have been able to save hundreds of thousands of dollars for some of our clients."
When can it be done?
Generally, the best time for a cost segregation study is the year the property is acquired or placed into service, which is the year the property becomes usable. This is the first opportunity any owner has for conducting the cost segregation study, and it is most beneficial to maximize depreciation deductions from the start. However, this is not the only time that it can be done.
A common misconception is that once the initial three-year statute to amend has expired, the tax payer can no longer take advantage of a cost segregation study. The truth is that any type of commercial real estate, regardless of size, placed into service as far back as Jan. 1, 1987, qualifies for a cost segregation study. Once the study is completed, the taxpayer is allowed to make an adjustment and take all of the accumulated depreciation in a single year, without filing an amended return. The benefits can be quite substantial.
For example, a $10 million office building in Phoenix, Ariz., placed into service in early 2005, had 100 percent of the property being depreciated over a 39-year schedule. The owner did a cost segregation study for the 2010 tax year. The study identified 8 percent ($800,000) of the depreciable assets could be reallocated to a five-year depreciation schedule. At a 35 percent tax rate, the taxpayer realized over $238,000 in savings over the first year. The 10-year net present value of these savings is around $190,000.
What is involved?
Many consulting firms will provide potential clients with a preliminary analysis for free. The analysis will give you information regarding the best timing strategy and a cost-benefit analysis based on some very general information you provide regarding the property.
A cost segregation study typically takes 30 to 60 days and the price can range from $5,000 to $15,000.
Industries that benefit the most:
• Medical Centers and Health Care Facilities
• Office Buildings
• Manufacturing Buildings
• Apartment Buildings
• Distribution & Warehousing Buildings
If you are an owner of a commercial real estate property and have not completed a cost segregation study of your asset, you may want to contact a commercial real estate consulting firm for more specific information on how your property may benefit. For a relatively nominal fee, you could potentially realize hundreds of thousands of dollars in savings.