Tax Reduction and Cost Segregation – Myths and Facts

Tax tips and tax help to assist taxpayers by describing options
for tax reduction and tax cuts through lawful tax deductions.

Tax reduction and tax deferral are both generated by cost segregation. However, this tool is not well understood by most real estate investors and by many tax preparers. The root cause of limited understanding regarding cost segregation and how it provides tax reduction is limited dissemination of factual data on the subject.

The most prevalent myths include:

• Cost segregation does not provide tax reduction, only tax deferral.
• Cost segregation is too expensive. It only works for properties with a cost basis of $10 to $20 million or more.
• Cost segregation is risky; it is a tax shelter likely to cause an audit.

All three myths are simply incorrect.

Cost segregation provides tax reduction by converting income which would have been taxed at the ordinary income rate (35% maximum) to income taxed at the capital gains rate (15% maximum). During the ownership period, cost segregation generates additional depreciation real estate investors can use to shelter income from the property or other sources. In many cases this income would have been taxed at 35%.

Upon sale, the property owner and tax preparer will collectively allocate the sales price. In most cases, short-life property such as carpet, vinyl tile and paving have depreciated and the market value of these assets (at the time of sale) equals their depreciated cost basis. In this event, the additional depreciation is taxed at the capital gains rate. Hence, the real estate investor gains both tax reduction and tax deferral.

Cost segregation used to cost $20,000 to $50,000 per property and was only financially feasible for properties with a cost basis of at least $10 million. However, fees for cost segregation studies are now much lower. It generally makes sense to order a cost segregation study if the cost basis of improvements is at least $500,000. In most cases, the first year tax reduction is at least two to four times the fee for the study.

The myth about cost segregation studies being a risky scheme is completely inaccurate. A properly prepared cost segregation study is encouraged by the IRS since it generates more accurate accounting. The Audit Techniques Guide is a 100-plus-page manual regarding the background and proper methodology for a cost segregation report.

Both the advisors and appraisers (who perform cost segregation studies) have studied and understand the Audit Techniques Guide. Cost segregation studies are encouraged by the IRS. In private correspondence, IRS staff has indicated a cost segregation study does not increase the change of an audit.

If you are a real estate investor or use real estate in your business, ignore the myths and obtain a free preliminary analysis to determine if you could benefit from a cost segregation study and increase your tax reductions and tax deductions.

Click here for a FREE preliminary analysis of tax savings resulting from your property.

Cost segregation produces tax deductions and reduces federal income taxes across the country and in every size market. Below are just a few examples of where cost segregation generates meaningful tax deductions.

City:

• Philadelphia, PA
• Boston, MA
• Denver, CO
• Memphis, TN
• San Francisco, CA
• Tampa, FL
• Hartford, CT
• Atlanta, GA
• Miami, FL
• Orlando, FL
• Allentown, PA
• Harrisburg, PA
• Lancaster, PA
• Greenville, SC
• McAllen, TX
• Tulsa, OK
• Charleston, SC
• Chattanooga, TN
• Palm Bay, FL
• Oxnard, CA
• Madison, WI
• St. Louis, MO
• Columbia, SC
• Lakeland, FL
• Youngstown, OH
• Knoxville, TN
• Detroit, MI
• Columbus, OH
• Des Moines, IA
• Cincinnati, OH

Cost segregation produces tax deductions for virtually all property types.

Property Type:

• Fast food restaurant
• Department store
• Auto dealer
• Convenience store
• Service center warehouse
• Self-storage
• Drugstore
• Land
• Multifamily
• Medical facility

Almost every industry, including the following, can generate cost-efficient tax deductions by using cost segregation.

Industry:

• Automotive parts distributors
• Frozen food manufacturing
• Apparel manufacturing
• Electrical component manufacturing
• Plastic and rubber products manufacturing
• Publishers
• Textile product mills
• Building supply dealers
• Wood product manufacturing
• Golf courses and country clubs

O’Connor & Associates is a national provider of investment real estate consulting services including commercial real estate appraisal, tax deductions, cost segregation, property tax, tax reduction, market research, highest and best use analysis, partial interest valuation, financial modeling, Brazoria county appraisal district, Tips and Tricks for Appealing Your Property Taxes in Galveston, Galveston county appraisal and Federal tax reduction. Appraisal services are provided for all commercial property types including nursing homes, discount stores, truck terminals, tennis clubs, supermarkets, country clubs, medical offices, mini-warehouses, restaurants, vacant lands, skating rinks, community shopping, centers, power centers, car wash facilities and service stations.

Tax Deferral 1031 Exchanges and Cost Segregation

Tax deferral through 1031 exchanges, or tax-free exchanges of real estate, have become a popular method of tax deferral of capital gains taxes. Almost by definition, individuals who utilize the 1031 exchange option are reluctant to pay taxes that can legally be avoided. 1031 exchangers have asked if they can receive tax deferrals and enhance depreciation. The short answer is yes.

A complete answer needs to consider the remaining cost basis for the property that has been exchanged. If the remaining cost basis is?minimal then tax deferral is minimal and, it is probably not financially feasible to utilize cost segregation. If the remaining cost basis (plus the amount of additional cash contributed) is at least $500,000, tax deferral is increased and it is worth reviewing whether cost segregation makes sense.

The total value of the new property is proportionally allocated to the remaining cost basis of the 1031 exchange property (and any additional basis from new investment). For example, if the five-year property is 10% of the value of the new property, and the remaining cost basis is $3,000,000, a value of $300,000 ($3,000,000 x 10%) would be allocated to the five-year property.

One interesting issue is whether five-year property in the new property is considered personal property. To gain the tax deferral benefits, a 1031 Exchange must involve like-kind property. For example, if you sell a house and purchase a lake house, boat and jet ski as your exchange property, the boat and jet ski would be considered ?boot?, taxable as ordinary income and the owner does not receive any tax deferral. The boat and jet ski are considered ?boot? since they are personal property and the property that was sold was real estate.

Since five-year property is referred to as personal property in IRS documentation, there has been confusion regarding this issue. The IRS defers to state law regarding whether items are real property or personal property for the purpose of determining whether there is ?boot.? Carpet and vinyl tile are both significant five-year life components. While they are considered personal property for depreciation purpose, they are considered real property by state law (in most states). Hence, they are not considered ?boot.? and the owner can experience tax deferral.

Tax deferral from cost segregation is effective for 1031 exchange purchases provided the remaining cost basis is at least $500,000. Exchange buyers can defer taxes and reduce taxes on the old property and increase depreciation for the new property.

Click here for a FREE preliminary analysis of tax deferral and tax savings resulting from your property.

Cost segregation produces tax deferrals and reduces federal income taxes across the country and in every size market. Below are just a few examples of where cost segregation generates meaningful tax deductions.

City:

• Baltimore, MD
• Houston, TX
• Bridgeport, CT
• Dallas/Ft. Worth, TX
• Hartford, CT
• San Francisco, CA
• Washington, DC
• Las Vegas, NV
• Memphis, TN
• Tampa, FL
• Albany, NY
• St. Louis, MO
• Tulsa, OK
• Columbus, OH
• Santa Rosa, CA
• Fresno, CA
• Detroit, MI
• Ft. Lauderdale, FL
• Cincinnati, OH
• Cleveland, OH
• Scranton, PA
• Indianapolis, IN
• Albuquerque, NM
• Wichita, KS
• Milwaukee, WI
• Stockton, CA
• Little Rock, AR
• Bakersfield, CA
• Oklahoma City, OK
• Nashville, TN

Cost segregation produces tax deductions amd tax deferrals for virtually all property types.

Property Type:

• Regional mall
• Truck terminal
• School
• Manufacturing/processing
• Retail
• Shopping center
• Cold storage facility
• Tennis club
• Country club
• Medical office

Almost every industry, including the following, can generate cost-efficient tax deductions and tax deferrals by using cost segregation.

Industry:

• Arts, Entertainment, and Recreation
• Laundry facilities
• Furniture stores
• Paper manufacturing
• Machinery manufacturing
• Metal manufacturing
• Computer and electronic manufacturing
• Golf courses and country clubs
• Textile mills
• Truck transportation

O?Connor & Associates is a national provider of commercial property real estate consulting services including gift tax valuations, insurance valuation,condemnation appraisals, tax deduction, feasibility studies, market research, property tax, income tax, feasibility studies, casualty loss, taxes, Tips and Tricks for Appealing Your Property Taxes in Fort Bend, Fort bend county appraisal, and Federal tax reduction. Appraisal services are provided for all commercial property types including multi-family housing, retail stores, hospitals, hotels, industrial properties, manufacturing facilities, medical offices, commercial offices, restaurants, self-storage units, shopping malls, shopping plazas and warehouse/distribution centers.

Apartment owners can face staggering expenses to maintain apartment communities. The upkeep of even a modest community could involve groundskeeping, unit renovation, and replacements, such as parking lot asphalt and fencing. Another steep expense is federal income tax - and in some areas an additional state tax on income - but through an innovative study known as cost segregation, the depreciation of property components can be used to help lower federal taxes.

Today, more apartment investors, especially those whose occupancy rates are challenged by the nation’s single-family housing, are taking a close look at every possible avenue to lower costs. That’s a frustrating task in the apartment business. One historically underused technique for saving money, in this case saving taxes, is to ensure that all depreciable items are reflected accurately on tax returns.

Those items are not limited to copiers, automobiles and heavy equipment. The list extends to a wide range of buildings and improvements. In fact, the IRS recognizes 130 items that depreciate over much shorter time periods than the standard depreciation of 27.5 years for an apartment community. Many of those items, such as parking surfaces, landscaping and even certain wall coverings, are present in large proportions on typical apartment communities.

A cost segregation analysis, when reflected on deprecation schedules, reduces taxable income now and also defers taxes on capital gain amounts until the community is sold. At that time, the recapture of taxes on the extra depreciation taken can occur at a much lower rate than the 35 percent max tax rate that was avoided with the extra losses.

Don’t forget the time value of money by deferring that inevitable tax by a few years. In light of the 130 IRS-identified “short life” items, this conservative tax-planning tool can help apartment owners allocate more costs to five-year, seven-year, 15-year and 27.5-year improvements versus the land value on apartment communities.

Apartment communities, according to IRS rules, depreciate over the course of 27.5 years. This is 10 years less than the depreciation estimated for office, retail and industrial properties, which equal quicker savings for apartment community owners. Items that are found in every apartment, such as carpet, linoleum, window treatments and appliances, are categorized as five-year items, meaning that they are typically replaced after five years of use.

Wide Range of Applications

Whether the community was recently purchased, has been owned for a while or is on the market to be sold, a cost segregation analysis can help at any stage of ownership by reducing federal income taxes and showing future depreciation. The optimum time to do this is preferably as soon as ownership is taken, whether the property was bought or built. Any commercial property built after Dec. 31, 1986, is eligible, and there are “catch-up provisions” to accommodate higher savings in the first year when a cost segregation study is completed for communities that have been owned for several years.

Communities of all sizes can benefit, from small communities of fewer than 10 apartments to communities that span several city blocks. If the property has an assessed value of at least $200,000, the cost segregation evaluation can almost always produce substantial federal income tax savings.

Preparing for a Study

A minimal amount of an owner’s time is required when working with a consulting firm that specializes in cost segregation. And it is advisable for the owner’s CPA or tax accountant to work with the consultant, ensuring the most advantageous application for that owner’s particular financial circumstances.

The original purchase price of the apartment community is the cost basis, so owners receive savings on their initial investment, as well as on improvements. With research that is both quantitative (square footage of asphalt, pavement, ect., or quantities of wall or window coverings, ect.) and qualitative (judgment of remaining life) a specialized analysis and calculation is conducted before a report is issued. This report becomes the backup documentation for federal income tax returns.

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