One of the worst sins of owning commercial real estate (or multi family residential) is simply depreciating the entire structure cost (net of land) over a period of 39 years. Yet this is what over 90% of commercial property owners do because that’s what their accountant told them to do. That is a huge mistake!
The IRS code says property owners have the right to accelerate the depreciation on the sub components of the entire property. Much of the internal mechanics and improvements to the building such as flooring, HVAC, Roof, Plumbing, Fixtures, landscaping and much more can be depreciated much faster. The range of years to depreciate these items is from 3,5,7,10 years to depreciate some of these items.
This will create a much larger depreciation figure in those all important early years putting tens or hundreds of thousands of more dollars in the property owners pocket in the form of tax savings! This strategy is called Cost Segregation and it works just like the title says. We are going to “segregate” much of systems of the structure out and legally increase their depreciation schedule rather than bundling them all together into 39 years.
Let’s say you had a building that was worth 2 million dollars for depreciation purposes (must subtract out land value as you cannot depreciate land) that you were depreciating over 39 years. This would mean you would depreciate around $51,300 per year for the next 39 years. Depending on your income tax rate, that might save you $20,000 of federal and state income taxes. This is a huge bonus on a commercial property that is already either housing your business or providing you income from ownership, debt pay down, and hopefully appreciation.
However, let’s say we are able to break out 1 million of that 2 million value using cost segregation and depreciate that over the next 7 years. (Different systems will use different depreciation schedules so we will just use 7 years for this example) So now you have 1 million divided by 7 years giving the owner $143,000 per year for the next 7 years plus the straight line 39 year depreciation for the additional 1 million. This is an additional $25,600 of annual depreciation totaling $168,000 of annual depreciation for the next 7 years!
Again, depending on tax rates you might save $58,800 per year in income taxes! If you understand the basics of time value of money this strategy is massive for your cash flow. Although saving $20,000 in income taxes is nice I would rather pocket almost $59,000 per year for the next 7 years. That totals almost $420,000 in your pocket over the next 7 years. So $420,000 as opposed to $140,000? Which is better for you as the investor? Who wouldn’t like an extra $280,000 in your pocket over the next 7 years? What could that extra money pay for…. College, Retirement, underfunded buy sell agreements, rapid debt pay down, buyouts, and so much more
Sounds great John but how do I take advantage of this program? First you will need a free initial study from a certified company who specializes in Cost Segregation. We are affiliated with just such a company and they do these all over the country and have for years. Just send us a quick email at email@example.com and we will get out the initial short questionnaire to see how much this strategy will benefit you. After you see the numbers and wish to go forward the cost segregation company will prepare the entire transaction for you for a fee. There is only a fee if you move forward and the fee will be far less than your savings. You be the judge after you see your savings.
If you know someone who owns a commercial property (yes apartment buildings will work) please forward this article to them. If you know a commercial real estate broker, they may or may not be aware of this strategy so forward it to them as well.
You may also have the ability to reach back for some of the previous years when you have not been utilizing this strategy on existing buildings. How would you like an extra fat refund check from your old Uncle Sam? You might be due one.
Lastly, if you rent a building but pay for the improvements you might qualify for this strategy as well. It’s worth looking into so give us a quick email.
Cost Segregation can be a huge asset to the commercial property owner’s cash flow and net worth. It is one part of an overall wealth strategy system that everyone needs to be implementing. I hope we can help you down your path.