One of the
primary goals for a property owner is to maintain a steady cash flow since it
is a key indicator of the financial health for any business. An
often-overlooked method for increasing cash flow is through a cost segregation
study. There are several advantages for a property owner to have a cost
segregation study performed, but perhaps the most appealing reason allows an
owner to accelerate the depreciation of real property which reduces current
year taxable income thus producing a cash stream by deferring taxes to future
years.
Real
property, which includes the structural components of an apartment building, is
generally depreciated over a lengthy 27.5 years on a straight-line basis;
however, IRS guidance and case law allow components of an apartment building’s
cost to be reclassified from 27.5 years to personal property depreciated over
5, 7, and 15 years at accelerated rates.
Although
cost segregation studies are one of the most valuable tax strategies available
to owners of commercial real estate today, it is advised that a qualified
engineer performs the study. An engineer provides a breakdown for each
component of each building. For an apartment complex, many of the items
segregated are those related to tenant amenities, for example a swimming pool.
There is a wide range of building components, such as electrical installations,
plumbing, mechanical components, and finishes that can be identified and
reclassified into shorter-lived asset classes. Components identified as land
improvement property including excavation/grading, asphalt paving, landscaping,
fencing, etc. can also qualify for increased depreciation. This adds up to
substantial savings to the client.
As an
example of the value of a cost segregation study, a recent purchase of an
existing apartment complex netted a cash flow of $456,050 over the life of the
facility based on the reclassification of 34% of the total purchase price (i.e.
$10.62 MM0) to 15, 7 and 5-year property. In another purchase, an owner was
able to secure a net cash flow increase of $864,280 over the life of the
apartment complex. The purchase price of the facility was given as $24.1 MM
with 27% of the assets reclassified as 15, 7 or 5-year property.
Apartment
complex owners can use a qualified cost segregation study as a financial
management tool to aid in their tax, accounting and insurance planning.
Virtually every taxpayer who owns, constructs, renovates, or acquires a
commercial real estate structure stands to benefit from a cost segregation
analysis. This popular tax strategy offers facility owners the opportunity to
defer taxes, reduce their overall current tax burden, and free up capital by
improving their current cash flow.
