Circ Cost Segregation


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Cost Segregation Studies, IRS

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Circ Cost Segregation

  1. 1. Cost Segregation: What Every Investor Should Know My Mission: Provide quality financing alternatives to individual and business clients with the highest degree of service by practicing honesty, integrity, and sound business ethics in enabling long-term relationships and successful problem solving when it comes to my clients’ real estate concerns. The highest compliment that I can receive is the referral of your family, friends, and colleagues. Thank you! Dan Email: [email_address] Office: (573) 234-4886 Fax: (866) 403-8248
  2. 2. Why You Need to Know <ul><li>Cost Segregation (CS) is a strategic approach to maximizing investment cash flow for property owners who have built, purchased, added to, or </li></ul><ul><li>remodeled real estate. </li></ul><ul><li>CIRC has strategically partnered with Scarpello Consulting to provide you with the best study possible. Our approach is designed to maximize your depreciation while minimizing the risk of audit exposure. This is accomplished by doing more than properly classifying an asset as real or personal property; we clearly document how the values of the various component assets were identified. This includes identifying improvements on the building plans, quantifying the property using the most detailed level of cost information available, and describing the costing method employed. </li></ul><ul><li>About 40% of CPAs who have clients who invest in real estate know about cost segregation. Fewer have an in depth understanding. The proper segregation of costs requires the knowledge of construction costs and techniques as well as related tax law. Our team has extensive estimating, engineering, and construction experience permitting us to identify and quantify items of personal property accurately and in a manner acceptable to the IRS. Additionally, our experience in the real estate and construction industries provides a unique base of experience to take advantage of the taxpayer privileges provided by the IRC and reported regulations. </li></ul><ul><li>CS will maximize your net cash flow, increasing it as much as 20% or more, on current and future properties. </li></ul><ul><li>Adding a seller paid cost segregation study showing associated increased cash flow can significantly enhance the marketability of a property. </li></ul>It’s not how much you make, it’s how much you keep. Cost segregation allows you to keep more by increasing your client’s net cash flow with accelerated depreciation.
  3. 3. What is Cost Segregation? <ul><li>There are four elements to any property: </li></ul><ul><li>1. Land </li></ul><ul><li>2. Land Improvements (i.e. fences and paving) </li></ul><ul><li>3. Building </li></ul><ul><li>4. Personal Property (Chattel) </li></ul>The IRS allows qualifying items of land improvements and personal property to be “segregated from the building structure” for tax purposes. Regulation § 1.167(a)-7(a) allows taxpayers to either depreciate individual items on a separate basis or to combine assets into group accounts and depreciate the group account as a single asset.
  4. 4. What is Cost Segregation? <ul><li>Useful lives on the qualifying items can be depreciated over 5 and 7 </li></ul><ul><li>years for personal property and 15 years for land </li></ul><ul><li>improvements instead of 39 years for commercial buildings and 27 </li></ul><ul><li>½ years for residential buildings. </li></ul><ul><li>A cost segregation study segregates the costs and the useful lives of </li></ul><ul><li>the individual property components. When the actual cost of each </li></ul><ul><li>individual component is available, this is a more simple procedure. </li></ul><ul><li>When only lump-sum costs are available, cost estimating techniques </li></ul><ul><li>are required. </li></ul><ul><li>The cost segregation study provides a new accurate depreciation </li></ul><ul><li>schedule. The increased tax deductions that commercial property </li></ul><ul><li>owners are legally entitled to take helps maximize property cash flow. </li></ul>
  5. 5. What is Cost Segregation? <ul><li>Cost segregation is a strategic tax savings tool that increases tax </li></ul><ul><li>deductions by accurately depreciating the land improvements and </li></ul><ul><li>personal property. </li></ul><ul><li>In her Money Found article Angie Granger, CPA states &quot;Cost </li></ul><ul><li>segregation is one of the IRS' cash-flow secrets that CPAs, </li></ul><ul><li>financial planners, real estate investment managers, and other </li></ul><ul><li>professionals can use to realize tax savings for their clients&quot;. </li></ul><ul><li>Cost segregation provides commercial property owners: </li></ul><ul><li>• Reduced Taxes </li></ul><ul><li>• Increased Cash Flow </li></ul><ul><li>• Maximized Annual Tax Depreciation </li></ul><ul><li>• Increased Net Income </li></ul><ul><li>• Reduced Property Taxes in Some States </li></ul>
  6. 6. History <ul><li>There are more than 75 IRS rulings, procedures and court cases </li></ul><ul><li>which allow for cost segregation studies. </li></ul><ul><li>1997 Landmark decision - Hospital Corporation of America vs. </li></ul><ul><li>Commissioner validates cost segregation, reinforcing the use </li></ul><ul><li>of ITC methodologies and precedents as applicable to </li></ul><ul><li>determining depreciation. </li></ul><ul><li>2004 Cost Segregation Audit Techniques Guide is issued by the </li></ul><ul><li>IRS to assist agents in reviewing cost segregation studies. It </li></ul><ul><li>provides an understanding of the IRS’s point of view towards </li></ul><ul><li>particular assets, defines various methodologies, and outlines </li></ul><ul><li>key components of a quality cost segregation study. </li></ul>Did you know tax code to allow 1031 exchanges was first enacted in 1986? It took years for people to understand the tremendous benefit. Guidelines for Cost Segregation were published in 2004. Cost Segregation is very much coming of age as a savvy tax strategy.
  7. 7. Current Guidelines <ul><li>,,id=134180,00.html </li></ul><ul><li>Cost Segregation Audit Techniques Guide - Table of Contents </li></ul><ul><li>Revision Date December 2007 </li></ul><ul><li>Table of Contents </li></ul><ul><li>Chapters: </li></ul><ul><li>Introduction </li></ul><ul><li>Legal Framework </li></ul><ul><li>Cost Segregation Methodologies </li></ul><ul><li>Principal Elements of a Quality Cost Segregation Study and Report </li></ul><ul><li>Review and Examination of a Cost Segregation Study </li></ul><ul><li>Appendix </li></ul><ul><li> Uniform Capitalization </li></ul><ul><li> Change in Accounting Method </li></ul><ul><li> Depreciation Overview </li></ul><ul><li> Relevant Court Cases </li></ul><ul><li> Statistical Sampling </li></ul><ul><li> Construction Process </li></ul><ul><li> Information Document Requests </li></ul><ul><li>Industry Specific Guidance </li></ul><ul><li> Casinos </li></ul><ul><li> Restaurants </li></ul><ul><li> Retail Industries </li></ul><ul><li> Biotech & Pharmaceutical Industry </li></ul><ul><li> Auto Dealerships </li></ul>While most of the Guide is rather dry, you might find the items classed as personal property in the industry specific guidance an interesting read.
  8. 8. Qualifying Assets <ul><li>Useful lives on the qualifying items can be depreciated over 5 and 7 </li></ul><ul><li>years for personal property and 15 years for land </li></ul><ul><li>improvements instead of 39 years for commercial buildings and 27 </li></ul><ul><li>½ years for residential buildings. </li></ul><ul><li>The most widely used lives are: </li></ul><ul><li>5-Year and 7-Year Property </li></ul><ul><li>IRC §1245 Tangible Personal Property </li></ul><ul><li>15-Year Property </li></ul><ul><li>IRC §1250 Building Components </li></ul><ul><li>27.5-Year Property (residential building) </li></ul><ul><li>39-Year Property (non-residential building) </li></ul>
  9. 9. Qualifying Assets <ul><li>Tangible Personal Property – 5 & 7 Year Useful Lives </li></ul><ul><li>Specialty plumbing, lighting and associated wiring (20%-50%) </li></ul><ul><li>Booths, lockers, benches, counters, kiosks, office furnishings. </li></ul><ul><li>Decorative mill work and removable wall coverings. </li></ul><ul><li>Carpeting, floor coverings, and window accessories. </li></ul><ul><li>Equipment for climate controlled rooms. </li></ul><ul><li>Computerized sales systems, surveillance, music and PA system. </li></ul><ul><li>Signage, some canopies, and awnings. </li></ul><ul><li>Non-permanent, moveable walls and partitions </li></ul><ul><li>Restaurant décor, eliason doors, drive through equipment, </li></ul><ul><li>kitchen HVAC, kitchen equipment hookups, beverage </li></ul><ul><li>equipment, etc. </li></ul><ul><li>The Accounting Rule for Personal Tangible Property is </li></ul><ul><li>200% Double Declining Depreciation </li></ul>You get the biggest cost segregation bang for your buck is in the first 5 to 7 years due to the tangible personal property write-offs. Because most commercial property owners typically turn their properties every 5 to 7 years, they should always be taking advantage of cost segregation.
  10. 10. Qualifying Assets <ul><li>Land Improvements and Other 15 Year property </li></ul><ul><ul><li>Driveways, sidewalks, parking lots, and pole mounted lighting. </li></ul></ul><ul><ul><li>Landscaping, gardens, and fences. </li></ul></ul><ul><ul><li>Pylons and footings for light poles, signs, and canopies. </li></ul></ul><ul><ul><li>Stonework imbedded in the ground or applied to exterior. </li></ul></ul><ul><li>The Accounting Rule for Land Improvements is </li></ul><ul><li>150% Declining Depreciation </li></ul>
  11. 11. Other Benefits <ul><li>A Cost Segregation study provides a taxpayer with information needed to take bonus deprecation and IRC §179 deductions. </li></ul><ul><li>Component Replacement Deduction </li></ul><ul><li>If a building component subsequently needs replacement, taxpayers can write off its remaining tax basis. </li></ul><ul><li>To illustrate, suppose a cost segregation study showed the initial value of a roof to be $500,000. Two years later, when the roof has an adjusted tax basis of $480,000, it needs to be replaced. The taxpayer could write off the entire adjusted tax basis and deduct a $480,000 loss. This is a great capability to have with older properties. </li></ul><ul><li>Cost segregation may result in lower local real estate transfer taxes. Localities </li></ul><ul><li>often impose these taxes based on a building’s fair market value. When a cost </li></ul><ul><li>segregation study reduces a building’s value, this produces a corresponding </li></ul><ul><li>reduction in the amount of the transfer tax due (and a potential reduction of </li></ul><ul><li>annual real estate taxes as well). </li></ul>
  12. 12. Rehab Tax Strategy <ul><li> If a property is going to be gutted and rehabbed, getting a </li></ul><ul><li> cost segregation study completed before gutting establishes </li></ul><ul><li> the value of all non-building components. Once the property </li></ul><ul><li> Is gutted, the non-building components can be written off in </li></ul><ul><li> full. </li></ul><ul><li>$2,000,000 office building x 25% personal property = $500,000 write-off </li></ul><ul><li> When the property rehab has been completed, a new cost </li></ul><ul><li> segregation study establishes the new accelerated </li></ul><ul><li> depreciation schedule for increased cash flow. </li></ul>
  13. 13. Cost Segregation Candidates <ul><li>Properties with more than $750,000 in buildings and tenant </li></ul><ul><li>improvements. </li></ul><ul><li>Owner plans to keep building for 3+ more years </li></ul><ul><li>Owned by individuals or for-profit entities paying taxes </li></ul><ul><li>New or existing buildings </li></ul><ul><li>All types of commercial properties and apartment buildings. </li></ul><ul><li>Special use structures – i.e. medical buildings, franchise </li></ul><ul><li>operations, car washes, car dealerships, etc. </li></ul><ul><li>Property acquired by owner after 1986. </li></ul>
  14. 14. Cost Segregation Candidates <ul><li>Average Percentage of Property Reallocated to 5, 7, and 15 </li></ul><ul><li>Year Depreciation with a Cost Segregation Study </li></ul><ul><li> Property Type Percentage </li></ul><ul><li> Reallocated </li></ul><ul><li> Manufacturing Facilities 30-70% </li></ul><ul><li> Golf Courses 30-50% </li></ul><ul><li> Medical Facilities 25-43% </li></ul><ul><li> Banks 25-43% </li></ul><ul><li> Restaurants 23-40% </li></ul><ul><li> Grocery Stores 27-40% </li></ul><ul><li> Hotels 20-40% </li></ul><ul><li> Auto Dealerships 20-35% </li></ul><ul><li> Retail Stores 10-40% </li></ul><ul><li> Apartments 20-30% </li></ul><ul><li> Offices 12-25% </li></ul><ul><li> Warehouses 10-17% </li></ul>
  15. 15. Cost Segregation Candidates <ul><li>Leasehold improvements can also qualify for a Cost Segregation </li></ul><ul><li>Study. Interior build-outs generally produce a proportionally higher </li></ul><ul><li>ratio of qualifying property. Therefore a Cost Segregation Study that </li></ul><ul><li>analyzes the costs of leasehold improvements can be even more </li></ul><ul><li>beneficial. </li></ul><ul><li>A cost segregation study on leasehold improvements is sometimes </li></ul><ul><li>called a tenant improvement study . </li></ul><ul><li>Determining the feasibility of a tenant improvement study requires </li></ul><ul><li>reviewing the lease to understand who owns the assets and </li></ul><ul><li>therefore will be depreciating them. When costs are shared and </li></ul><ul><li>there is a landlord contribution things get a bit more complicated. </li></ul>
  16. 16. Feasibility Considerations <ul><li>Passive Loss </li></ul><ul><li>Taxpayers with multiple properties can often qualify as a real estate </li></ul><ul><li>professional enabling them to offset other income with losses </li></ul><ul><li>created by the added deprecation realized by a study. </li></ul><ul><li>Taxpayers who spend 15 hours per week (750 hours per year) </li></ul><ul><li>materially participating in real property are generally able to be </li></ul><ul><li>considered real estate professionals per IRC. </li></ul><ul><li>If the owner leases the building to a business that they own and </li></ul><ul><li>materially participate in, if by leasing the building to the business at </li></ul><ul><li>the highest possible rental FMV you generate more rental income, </li></ul><ul><li>additional depreciation will benefit to the extent of that income. </li></ul>
  17. 17. IRS Guidelines <ul><li>Of the 13 essential elements of a quality cost segregation study, </li></ul><ul><li>the very first item the IRS lists is </li></ul><ul><li>“ Preparation By An Individual With Expertise And Experience.” </li></ul><ul><li>“ The preparation of cost segregation studies requires knowledge of </li></ul><ul><li>both the construction process and the tax law involving property </li></ul><ul><li>classifications for depreciation purposes.” </li></ul><ul><li>“ However, the possession of specific construction knowledge is not the </li></ul><ul><li>only criterion. Experience in cost estimating and allocation, as well as </li></ul><ul><li>knowledge of the applicable law, are other important criteria.” </li></ul><ul><li>“ A quality study identifies the preparer and always references his/her </li></ul><ul><li>credentials, experience, and expertise in the cost segregation area.” </li></ul>Some accounting professionals will perform cost segregation studies. Unless they have specific construction knowledge , they do not meet the very explicit IRS requirement of an individual with expertise and experience . The cost segregation studies SC has reviewed that were performed by CPAs missed 50% to 60% of the allowable deductions because the CPAs didn’t understand the construction process and didn’t know what was inside the walls.
  18. 18. Depreciation Comparison Again, the biggest bang for the buck is in the first 5 to 7 years. Because most commercial property owners typically turn their properties every 5 to 7 years, they should always be taking advantage of cost segregation.
  19. 19. New Shopping Center Assuming a 9% cap rate, the 2007 additional benchmark tax savings of $297,564 increases cash flow by 16%. Assuming a cap rate of 7%, the increase is almost 20%. This tax savings of almost $300,000 is CASH in the owner’s pocket in 2007.
  20. 20. Nevada Professional Plaza Assuming a 9% cap rate, the benchmark 2008 additional tax savings of $234,959 increases cash flow by 22%. Assuming a cap rate of 7%, the increase is almost 27%. The almost quarter of a million dollars is extra CASH in the owner’s pocket in 2008.
  21. 21. Medical Development The benchmark 2007 additional tax savings of $237,829 reflects catch up depreciation (increases cash flow, assuming a 10% cap rate, by 31.6% in 2007). Again, the almost quarter million dollars is CASH in the owner’s pocket in 2007.
  22. 22. Cancer Center - Antioch The benchmark tax benefit in 2008 of $154,371, assuming a cap rate of 10%, increases 2008 net income by 26.44%. The $154,371 is additional CASH in the owner’s pocket in 2008.
  23. 23. So. California Hotel
  24. 24. How to Get Started <ul><li>Request a complimentary Cost Segregation Benchmark Study </li></ul><ul><li>WE NEED TO KNOW: </li></ul><ul><li>1. Date of Ownership / Property Transfer Date </li></ul><ul><li>2. Cost of Commercial Property (Excluding Land) </li></ul><ul><li>3. Type/Use of Building (Medical Center, Office Building, </li></ul><ul><li> etc.) </li></ul><ul><li>4. Size of the Building(s) (sf) </li></ul><ul><li>5. Current Depreciation Schedule (for property purchased in prior years) </li></ul><ul><li>6. Capital Improvements – Type/Date/Cost </li></ul><ul><li>7. Current Tax Rate (if available) </li></ul><ul><li>You will receive a benchmark study, NPV analysis, and fee </li></ul><ul><li>proposal to perform the engineering study. </li></ul>
  25. 25. Then What Happens? <ul><li>Owner signs engagement letter and pays an agreed upon engagement fee. </li></ul><ul><li>Owner Provides Building Documentation </li></ul><ul><li>(appraisal, depreciation schedule, blueprints, G702, G703, etc.) </li></ul><ul><li>CIRC and SC then: </li></ul><ul><li>Inspects and photographs the property to document the classification of capitalized costs into their appropriate class lives. </li></ul><ul><li>Reviews all cost details and available blue prints. </li></ul><ul><li>Reconciles all construction costs. </li></ul><ul><li>Uses trending estimates to account for location, time, and physical condition. </li></ul><ul><li>Reviews for allocation of soft costs to any direct cost. </li></ul><ul><li>Make a determination regarding proper tax life and recalculate depreciation and the applicable 481(a) adjustment (prior year purcase) </li></ul><ul><li>Prepare and draft Form 3115. (prior year) </li></ul><ul><li>Prepares the final report with supporting documentation on CD. </li></ul><ul><li>Provide road map for future purchases. </li></ul><ul><li>Typical Engagement Letter period 30-60 days, Final Report is typically 6-8 weeks. </li></ul>
  26. 26. Cost Segregation Summary <ul><li>• Cost Segregation is the IRS approved method of re-classifying </li></ul><ul><li>components and improvements of a investment property to allow accurate </li></ul><ul><li>depreciation of the property. </li></ul><ul><li>• Applicable to both owners and leaseholders. Feasibility needs to be </li></ul><ul><li>determined on an individual case basis. </li></ul><ul><li>• The net result creates significant acceleration of available tax deductions. </li></ul><ul><li>• Traditionally Big 4 CPA firms and National Appraisal firms with </li></ul><ul><li>engineering departments have used cost segregation with their large </li></ul><ul><li>clients. Economies of scale have prevailed and the tax benefit is available </li></ul><ul><li>to most investment property owners. </li></ul>
  27. 27. Cost Segregation Summary <ul><li>While most accountants and commercial real estate practitioners have </li></ul><ul><li>rudimentary understanding of using cost segregation to increase </li></ul><ul><li>depreciation and decrease federal taxes, many overlook the process because of a misunderstanding of cost or financial feasibility. </li></ul><ul><li>The execution rate for cost segregation is less than 10% because </li></ul><ul><li>of limited knowledge regarding the cost of a survey and the size </li></ul><ul><li>of properties for which cost segregation studies are financially </li></ul><ul><li>feasible. </li></ul><ul><li>IRS favorably supports cost segregation to allow payment of less tax in early years of the investments. Many real estate investors are </li></ul><ul><li>unintentionally overpaying federal income taxes. In addition, they </li></ul><ul><li>are paying federal income taxes earlier than necessary. </li></ul><ul><li>A seller paid cost segregation study can be a great sales incentive. </li></ul>
  28. 28. Why CIRC & SC? <ul><li>Our studies comply with the IRS standards stipulated in the Audit Techniques Guide for Cost Segregation Studies. </li></ul><ul><li>SC completes a complimentary review of the results of a fully engineered study. Net Present Value analysis usually shows at significant benefits to cost ratio. </li></ul><ul><li>SC has a team of engineers on staff as well as tax professional with specialized expertise in cost segregation to answer technical questions when needed. </li></ul><ul><li>Combine the study with CIRC financing alternatives to maximize the leverage of your investment. </li></ul>
  29. 29. Contact Information <ul><li>For Additional Information or a </li></ul><ul><li>NO-COST, NO-OBLIGATION </li></ul><ul><li>Cost Segregation Benchmark Review </li></ul><ul><li>Daniel Peery </li></ul><ul><li>Commercial Investment Research Center </li></ul><ul><li>Office: (573) 234-4886 </li></ul><ul><li>Fax: (866) 4038248 </li></ul><ul><li>[email_address] </li></ul>My Mission: Provide quality financing alternatives to individual and business clients with the highest degree of service by practicing honesty, integrity, and sound business ethics in enabling long-term relationships and successful problem solving when it comes to my clients’ real estate concerns. The highest compliment that I can receive is the referral of your family, friends, and colleagues. Thank you! Dan