Commercial Real Estate Investing From A-Z Depreciation: Which Asset Classes Are Best for Cost Segregation?
What is cost segregation? Are there asset classes that have better depreciation than others? Cindy Blumenfeld, Director of Client Development at Engineered Tax Services shares her knowledge.
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What is cost segregation, and when should people get that study done?
It's a study for depreciation of an investment property, not the primary residence that you live in, but any investment property, it could be commercial, it could be a house, or an office condo that you're doing significant leasehold improvements to. The IRS for some reason has commercial property being depreciated over 39 years, and residential, such as apartment buildings 27.5 years. That means that, let's say you spent $5 million to buy or build a building, not including land, land isn't depreciable, and your CPA takes that $5 million and divides it by 39 years, that's how much can write off every year, and that doesn't make a whole lot of sense, or give the owners a whole lot of benefit because none of the components in the building lasts 30 or 40 years. An alternate method, not only approved by the IRS, but preferred by the IRS is via an engineered cost segregation study. It's basically an engineering appraisal of the building for tax purposes.
Is there a particular asset class that is more favorable for someone who needs that depreciation that year?
When you turn that building upside down, and the more things that fall out of it the better, those are all the things that we're going to reclassify. Maybe there are more benefits in multifamily, or a retail store, or a manufacturing facility that has more different components inside it. I know self storage is a hot market right now, and depending on what the structures are made out of, if they're metal, or aluminum, as opposed to concrete, they can be depreciated over a 15 year life. We do a lot of restaurants, McDonald's, for example, and the franchisees don't own the shell of the building, which is a 39 year asset anyway, we can't accelerate it, but all the components inside the building we can. I had one McDonald's client that we did a portfolio of eight locations, he had acquired them about five or six years prior to us doing this study, and we were able to recapture all that missed depreciation, giving him back over a million dollars in cash.
Are there any other tips for investors to take advantage of depreciation that is important for them to know?
We didn't talk about energy yet, we also certify for 179D and the 45L energy certifications. This is for bigger commercial real estate, 45L is a tax credit, we've been talking about depreciations, which is tax deduction. If I got somebody a $500,000 tax deduction, they would have to times that by their tax rate, and that's their net cash benefit, whereas a tax credit is a dollar for dollar straight credit. The 45L had expired, they're reinstating it as of January 2023 and that's for large, low rise multifamily development, three stories and under, and that would go to the developer, a couple of $1,000 per door or dwelling for designing with the ultimate energy efficiency. That's where we come in, it has to be certified by an engineer. And the 179D has actually been out since 2006, and never got the front page recognition it was due, it was a temporary incentive, it was out for a few years, it expired for a few years. They reinstated it and made it retroactive, and it expired again for a few years, reinstated, made retroactive, it expired again. It was just going around like that for a while and now they finally made it permanent.
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