Cost Segregation for Commercial Real Estate Investments
Investors / owners want to defer capital gains. That’s the point of doing a 1031 tax deferred exchange. Investors and owners also want to lower taxes. Cost Segregation and 1031 Exchanges are two powerful tax strategies that owner / investors can utilize to defer capital gains and reduce taxes. I’ve posted many times regarding 1031 exchanges so let’s take a brief look at Cost Segregation.
Let’s take a quick look at the role of depreciation. Depreciation apportions the cost of an asset over its useful life and uses different depreciation schedules depending whether its residential investment property such as apartment complexes or commercial investment property such as triple net retail buildings, malls, distribution centers, warehouses, office buildings, etc.
Residential investment income real property (including apartment complexes) is generally depreciated over 27.5 years and commercial income real property is generally depreciated over 39 years.
However, personal property has always been allowed accelerated depreciation. Generally, on a five, seven or fifteen-year schedule, but in some instance, 100% in the first year of ownership.
IRS Acceptable Cost Segregation Study
This accelerated method of depreciation is determined by a cost segregation study. Meaning that an owner / investor can have a cost segregation study conducted to reclassify assets from real property to personal property to obtain tax benefits due to the accelerated depreciation periods. The Tax Reform Act of 2018 allows certain assets to be depreciated 100% in the first year.
The IRS requires that an actual study be performed by companies or accounting firms who specialize in this area and employ engineers and/or construction management professionals to construct a valid IRS acceptable cost segregation study. So, a sizable tax deduction can be generated by reclassifying certain real property, sec 1250 to personal property, sec 1245.
Also keep in mind that land can’t be depreciated, only the improvements.
Additionally, the quicker depreciating after a cost segregation study under the new Tax Reform can potentially create tax consequences when the property is sold at some later date. If items are depreciated to a zero basis and those items have a value when sold the seller will potentially have to recapture the prior deprecation to the extent of the gain as ordinary income.
A primary reason that c-stores, convenience stores such as 7 Elevens and Circle Ks are such a popular asset is that generally the gas dispensing equipment, including tanks, dispensing pumps, check out registers can be depreciated on a seven-year schedule.
What I’ve presented above is only a rough brief overview and as always, consult with your tax professional for details.
Whether you’re making a commercial real estate investment in Santa Monica, Los Angeles, Columbus, Ohio or anywhere in between, strategies such as the above can save you significant tax dollars in the shorter term. In the end, the IRS always wins.
If there’s any way I can help you find that a commercial real estate investment that’s just right for you, please feel free to call me, Scott Harris, at (310) 473-4789 or (614) 905-6614.