Don’t let cost segregation scare you, it could be your best friend. Recently on The Commercial Real Estate Show, I spoke with Mike Morris, Managing Director of Ernst & Morris for a quick breakdown of cost segregation and how it can create more cash flow for you.
One of those ways to increase cash flows for your commercial properties is through cost segregation studies. I've done some of these studies myself and it's remarkable how you can increase wealth and create more cash flow and it's very straightforward and surprisingly, not a lot of people are doing it.
The Basics: What Is a Cost Segregation Study
Morris said that a cost segregation study, (“cost seg study” for short) is simply “an analysis of a building and its components.” The IRS requires taxpayers for commercial buildings to depreciate a building over 39 years. Multi-family residential building owners get to depreciate the building 27.5 years. In both cases, property owners are allowed to write off certain site improvements over 15 years and then personal property over 7 or 5 years.
The ability to depreciate assets over 5 years instead of 39 years defers your tax liabilities and it also increases cash flow for people that have these studies done.
And if you haven’t taken advantage of a cost segregation study before, there's also a great opportunity to “go back”. “The IRS has allowed taxpayers to go back as far as 1990 without amending returns to have these studies done to catch up on the depreciation they should have done from day one,” Morris said.
One of the benefits of owning investment real estate is that you can depreciate it and use more of that cash to build wealth. And by deferring the taxes, you’re able to create more cash flow and more wealth.
It’s a true “no brainer”. Morris agrees saying, “A dollar in your pocket today is worth more than a dollar in your pocket tomorrow. Finance 101. And that’s what cost seg brings to the table.”
Cost seg studies are cost effective. Morris says a typical cost is $5,000-$7,000. The property size and type dictate the fee. Warehouse is probably less expensive, “just four walls, a roof, some site improvements and some minor interior finishes,” but they can do a cost seg study on any type of property in any location in the U.S., all the way up to a research development facility or for “for-profit” hospitals, there are special HVAC and surgical electrical items that qualify. Even a privately held golf course is a good candidate for a cost seg study because there are a great deal of costs involved in a golf course that can be written off for 15 years, like cart paths, irrigation, retaining walls, and sand traps.
“Basically, the IRS looks at what's related to the operation of the building vs. what’s related to the operation of the taxpayer’s business,” said Morris.
There are certain kinds of properties that are more beneficial than others to do studies on. Morris said supermarkets are great candidates for a cost seg study.
Also, with just some basic information from a taxpayer, Ernst & Morris can provide a complimentary estimate upfront with the cost of the study vs. the benefit.
They’ve completed 18,000 studies so they certainly have a large database of all the different types of properties they have studied, so they are able to draw on that experience to deliver their estimates.
The lighting, the electrical, the mechanical, the plumbing utilities, and even IT, can be segmented out and written off. Whether it's a purchase, a renovation or a retrofit, cost segregation is an option to consider to help improve cash flow and build wealth.
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