Cost Segregation - 101

The Key to Unlocking Income Tax Savings & IncreasedCash Flow for Commercial Property Owners

Agenda

• Intro• What is Cost Segregation?• History of Cost Seg• Who Qualifies?• Benefits of Cost Seg• Cost Seg Class Lives• How to Share Cost Seg• Q & A - Conclusion

• Commercial property owners areunaware of this tax strategy.

2 Major Problems

• There are thousands uponthousands of property ownersoverpaying their taxes.

CB Richard Ellis Acquires CostSegregation Business from

Marshall Stevens“This is an attractive opportunity to expand the scopeof services we offer clients,” said Cal Frese, CBRichard Ellis’ CEO. “Virtually every property owner,and every company that leases space, can benefit froma cost segregation analysis. We are now the only realestate services company with the resources andexpertise to provide clients with this service, anotherway that we are achieving differentiation in themarketplace.”

The U.S. Treasury Department States:

“Cost Segregation is a Lucrative TaxStrategy that should be used in almostEvery Major Purchase of CommercialReal Estate.”

– Wall Street Journal - June ’03

Real Estate Tax Strategy

An IRS approved tax strategy forcommercial property owners to shortenthe depreciation on their buildings forincome tax purposes.

It is a combination of tax law andengineering principles which reducescurrent income tax obligations.

What is Cost Segregation:

In short, it is the correctmethod to depreciate

commercial real estate.

What is Cost Segregation:

Don’t CPA’s Handle This?

• Cost Segregation is a relatively new concept.

• Because a cost seg study is a combinationof tax law and engineering principles, mostaccounting firms do not offer in house.

• The IRS recommends an engineer basedapproach to identify and reclassify buildingcosts into appropriate categories.

Cost Segregation:Origin & Case Law

The Tax Reform Act of 1986

Before

• Investment Tax Credits(ITC)

• Component Depreciation

• Real Estate depreciatedover a period of 19 years

After

• Commercial Real Estatedepreciated over 31.5 years

• Residential Real Estatedepreciated over 27.5 years

• In ‘93 – Commercial depr.changed from 31.5 to 39years

Cost Segregation History:Origin & Case Law

• U.S. Tax Court Ruling (1997):

They ruled that the practice ofsegregating building costs, for taxpurposes, was allowable.

Cost Segregation History:Origin & Case Law

• Landmark Cases:

- Walgreens Court Ruling (1996)

- Hospital Corp. of America(HCA) Ruling (1997)

Cost Segregation History:Origin & Case Law

• Landmark Cases:

Walgreens Court Ruling (1996)

Cost Segregation History:Origin & Case Law

• Landmark Cases:

Walgreens Court Ruling (1996)

Cost Segregation History:Origin & Case Law

• Landmark Cases:

Walgreens Court Ruling (1996)

Cost Segregation History:Origin & Case Law

• Landmark Cases:

Hospital Corp. of America (HCA)Ruling (1997)

Cost Segregation History:Origin & Case Law

• Landmark Cases:

Hospital Corp. of America (HCA)Ruling (1997)

Cost Segregation History:Origin & Case Law

• Landmark Cases:- Walgreens Court Ruling (1996)- Hospital Corp. of America (HCA) Ruling (1997)

• U.S. Tax Court Ruling (1997):“Certain assets in the hospital facilities could be consideredpersonal property and depreciated over a 5-year period.”

• IRS Action on Decision (Sept. 3, 1999) :“We acquiesce in this decision…The issue as to whether thevarious disputed items are structural components or tangiblepersonal property is a factual question.”

The IRS Website States:

“The HCA ruling effectively reinstated aform of component depreciation for certainbuilding support systems, such as theelectrical and plumbing systems that directlyserve tangible personal property. Therefore,cost segregation methodologies previouslyused to allocate the cost of a buildingbetween structural components and ITCproperty can now be used for §1245(personal) and §1250 (real) property.”

Cost Segregation:Origin & Case Law

After the 1997 Hospital Corp. Ruling

• Very large commercial property ownersbegan utilizing cost segregation

• At that time, costs to conduct a study werehigh and rules were vague, so generally itwas only profitable for properties over $10million.

But……

Audit Techniques Guide

In 2002, the IRS finalized its “CostSegregation Audit Techniques Guide to:

• Clear up any vague rules

• Layout audit techniques and explain whatIRS auditors should identify in a costsegregation study

Cost Segregation Qualifications?

• Properties purchased, built,renovated, acquired, after 1986

• Building cost basis over $250,000• Tenant Improvements over $100,000• Owned by a “For Profit” entity• Owner has taxable income• Property will be held at least 3-5 years

Who Should Not Do Cost Seg?

• Property owners who have no taxliability.

• Investors who are flipping propertiesin 1-2 years.

Kinds of Buildings

• Restaurants,• Office Bldgs.• Medical/Dental Offices• Manufacturing/Warehouses• Retail/Shopping Centers• Self-Storage Facilities• Hotels/Motels• Apartment Bldgs.• Almost any commercial property

Traditional Depreciation

39 yrs Commercial or 27.5 yrs Residential Rental

100%

39 Year

Property

$1,000,000

Traditional Depreciation

Depreciating$25,641 every year

for 39 years.

Desktop Approach

90%

10%

39 Year

Property

$1,000,000

Desktop Approach

90%

10%

39 Year

Property

$1,000,000

“An Accurate cost segregation study maynot be based on non-contemporaneousrecords, reconstructed data or taxpayer’sestimates or assumptions that have nosupporting record.”

Source: (IRS Audit Techniques Guide, pub. April 2004)

…enter Cost Segregation

Why Shorten Depreciation?

C

A

S

H

Why Shorten Depreciation?

C

A

S

H

T

A

X

E

S

Why Shorten Depreciation?

• Tax savings range 7% - 12% of buildingcost (minus land)

• $1m property = $70k to $120k cash inpocket savings usually within 5 yrs

Other Benefits…..

Catch-Up Depreciation

• Purchased Property in 2009

• Cost Segregation done for 2015

Catch-up depreciation is the difference in the depreciation theytook and the depreciation they would have taken had they done a

CS study back in 2009.

Taken in the tax year for which the study is conducted

Catch-Up Depreciation

•The opportunity here would be clients thatpurchased property years ago

•Letting them know about potential catch-updepreciation could be very beneficial to theirfinancial health without amending tax returns

•Providing an idea that many tax professionals arenot aware of, thus separating yourselves in themarketplace

Bonus DepreciationAdditional First-Year Deprecation for New Property

Example:

Purchase of existing building = $1m

New tenant improvements = $300k

Cost seg can be done on the building andTIs, but only TIs would qualify for Bonus

Engineered Cost Segregation

The IRS requires that aproperty owner cannot dotheir own cost segregationstudy.

How is it done?

How is it done?

Cost Segregation Class Lives

5 YearPersonalProperty

$300,000

15 Year LandImprovements

$150,00039 Year

RealProperty

$550,000

Cost Segregation Class Lives

55%

30%

15%

5Year

15Year

39Year

39 Yr Property - Foundation, Walls, Roof, Doors,

Hardware (Real Property)

Cost Segregation Class Lives

55%

30%

15%

5Year

15Year

39Year

39 Yr Property - Foundation, Walls, Roof, Doors,

Hardware (Real Property)

15 Yr Property – Landscaping, Parking

Lots, Sidewalks, Dumpster Enclosures,Flag Poles (Land Improvements)

Cost Segregation Class Lives

55%

30%

15%

5Year

15Year

39Year

39 Yr Property - Foundation, Walls, Roof, Doors,

Hardware (Real Property)

15 Yr Property – Landscaping, Parking

Lots, Sidewalks, Dumpster Enclosures,Flag Poles (Land Improvements)

5 Yr Property –Carpeting, DecorativeMillwork, Electrical andPlumbing for specialtyequipment (PersonalProperty)

Thank You!

For a free estimate or to learn more,

see us online

www.natcss.com

Cost Segregation

A Tool To Build Trust

How happy would your clients be if you canshow them upfront income tax savings?

Cost Segregation

A Tool To Build Trust

• Getting a cost segregation projection toshare with a new or old client is a freeservice we provide

• No selling or buying anything – justeducating and sharing

First Steps – Get a FreeProjection

• Complete a one page form• Or cost of bldg. and/or TI’s less land• Placed in service date• Type of bldg.• Review Preliminary Projections

• Additional Depreciation• Tax Savings• NPV Numbers• One Time Fee

Getting Started on a CostSegregation Study

• Sign proposal and collect 50% deposit• Gather building blueprints• Conduct a site visit• Engineers review plans and complete the

engineering on the property• Tax manager completes the study• Final delivery to client and CPA in about

4 – 6 weeks and collect remaining balance• CPA applies study and client saves cash

Time is Money

A dollar today is worth more than a dollar tomorrow, so naturally atax deduction today is worth more than a tax deduction tomorrow.

40 years ago, 1975, the price was…

Gas.......................$ .55 per gallonAverage home......$ 45,600Average income...$ 15,734 year

What will today's dollarbuy in 40 years? Not much!

FAQ’s

• Will a study trigger an IRS audit?

• Is there audit protection?

• How much is a cost seg study?

• What about a 1031 exchange?

• Do we prepare Form 3115 (change inaccounting method)?

Summary

A Cost Seg Analysis Should Provide These Benefits:

• Substantial return on investment• Tax benefits via increased tax deductions for

depreciation• Opportunity to contact prior clients to claim

“catch up” tax deductions in the current year• Increased cash flow to buy additional real estate• If done right - will withstand IRS scrutiny

Thank You!

For a free estimate or to learn more,

see us online

www.CostSegregationService.com