The guys explain everything about Cost Segregation and why it is an essential tool for commercial real estate investors. They reveal information that is helpful for any level investor including the fact that the government has specific criteria to determine if you are an active or passive real estate professional. Which one are you? The tax implications matter.
-Residential and multi-family commercial are depreciated over 27.5 years. Other commercial assets depreciate over 39 years. Cost Segregation: is an IRS approved method, an engineering based, identify certain assets as 5 year depreciable assets to accelerate depreciation for tax gain.
COMMON COST SEGREGATION ITEMS IN MULTI-FAMILY
Interior can be depreciated over 5 years: Floor tiles, carpeting, appliances, cabinetry, window treatments, countertops, shelving
Exterior can be depreciated over 15 years: Carports, exterior buildings, Pool area, landscape areas, paved areas, exterior lighting.
WHEN IS IT NOT BENEFICIAL TO DO A COST SEGREGATION STUDY
-Timing is everything. If you upside down on a property. If the property is renting at a cash loss
COST SEGREGATION IS BENEFICIAL IF YOU ARE GOING TO HOLD AN ASSET FOR 3 OR MORE YEARS.
-Hard assets of the building, structure and assets inside.
SLIDE 1: MADISON SPEC
-They do cost segregation, title insurance, escrow, closings, 1031 exchange, lease abstract, lease administration, lease software training, CAM reviews, Financial Due Diligence, Argus Runs, Variance reports, physical due diligence, offering memorandum,
SLIDE 2: COST SEGREGATION IN A NUTSHELL
-IRS approved method that uses engineering-based study that reclassifies certain assets to shorter depreciable lives resulting in accelerated depreciated tax deduction in the earlier years of property ownership. Applies to owners of investment property or property used to operate a business.
SLIDE 3: DEPRECIATION FUNDAMENTALS
-Tax law requires that commercial properties be depreciated over 39 years and residential rental properties over 27.5 years. There is a need to capitalize the expenditure, unlike a period cost such as payroll or rent.
SLIDE 4: COST SEGREGATION FUNDAMENTALS
-Must have a qualified engineer walk the property, Reclassify real property expenditures, Break out components that can be depreciated over a shorter life. Accelerate tax depreciation deductions. Produce significant non-cash deductions in the form of depreciation.
SLIDE 5: WHO BENEFITS FROM A COST SEG STUDY?
-It applies to all real estate owners who are current income taxpayers:
–Estates and Trusts, Individuals, Corporations, Partnerships, LLCs
SLIDE 6: WHEN DO A COST SEG STUDY?
-After close because it is based on the purchase price. New Acquisitions. Newly-constructed, renovated or expanded facilities. Facilities built or acquired within the past 10 years for which a cost seg study has not been completed. No statutory limit
SLIDE 7: CATCH-UP DEPRECIATION LOOK-BACK STUDY
-Reduce taxable income immediately,Catch-up deductions (All in one year), No amended return required. File Form 3115 (automatic method change) with tax return.
SLIDE 8: COST SEGREGATION – LANDMARK CASES
-Hospital Corp of America v. Commissioner (1997)
SLIDE 9: COST SEGREGATION AND PARTNERSHIP TAXATION ISSUES
-754 Basis Step Up (Usually a partner sales, based on current value, not what they paid)
-1031 Exchange (Defer gain by buying another property)
-Tenancy in Common (TIC) (an arrangement in which two or more people have ownership interests in a property or parcel of land)
-Short-Tax years/Placed in service dates
SLIDE 10: ACTIVE VS PASSIVE REAL ESTATE PROFESSIONAL
-Active Real Estate: RE activity or business in which the taxpayer works on a regular, continuous and substantial basis.
-Passive Real Estate: RE activity or business in which the taxpayer does not materially participate on a regular, continuous and substantial basis.
—Active RE losses offset against all active OR passive income.
—Passive RE losses only offset other passive investment activity income.
**Talk to your tax professional to know if you are an active or passive real estate investor.
SLIDE 11: ACTIVE REAL ESTATE PROFESSIONAL
-To be an active RE Professional, taxpayer must provide more than ½ of total personal services in property trades or businesses in which they materially participate and perform more than 750 hours of service during the tax year in real property trades or businesses.
-To include work as an employee such as a real estate broker or property manager as part of the 750 hours, the individual must maintain a 5% ownership of the company at the time of work.
–Keep records of all of your activity. The onus is on you.
SLIDE 12: PASSIVE REAL ESTATE PROFESSIONAL
-If you do not qualify as a real estate professional, you are allowed up to $25,000 passive loss if your MAGI (Modified Gross Adjusted Income) is $100,000 or less (Filing status MFJ – married filing jointly). The allowance fazes out at a rate of 1:2 for every dollar over $100,000, completely fazing out at $150,000.
SLIDE 13: PREMIUM/DISCOUNT CALCULATION VS REPLACEMENT COST NEW (RCN)
-RCN: The engineering calculation used to reconstruct what it would cost to replace a building if it were actually built today.
–When utilizing the engineering approach (ie. Approved IRS approach), the cumulative estimation of the valuation of assets will most likely be either higher or lower than the actual depreciable basis.
–A Premium/Discount Calculation is performed to align the estimated valuation with the actual depreciable basis.
SLIDE 14: UNDERSTANDING ASSET OBSOLESCENCE
-The IRS in Rev. Proc 87-56 sets forth the class lives for all assigned property.
-These class lives reflect an estimation of the longevity of the assets, from a tax standpoint.
-How long an asset actually lasts – it’s “useful Life” – is a separate concept and should not be confused with the depreciable asset life (eg. 5,7 or 15 year property) assigned by the IRS.
-The engineering approach analyzes an asset’s “useful life”, and then compares it to the remaining useful life of an asset. The amount that is “used up” is called an asset’s obsolescence.
-A calculation is performed in order to adjust the value of the asset to reflect any such obsolescence.
SLIDE 15: TAX PLANNING STRATEGIES
-Estate Tax Planning
–Cost segregation studies can be performed on inherited property which receive a step-up in basis and generate tax savings.
–Step-up basis is the readjustment of the value of an appreciated asset for tax purposes upon inheritance determine to be the higher market value of the asset at the time of inheritance.
—If you inherit a property that your grandfather bought for $50K that is now worth $2M, you may need a cost segregation study for tax savings.
SLIDE 16: TAX CUTS AND JOBS ACT OF 2017
-Was passed in late 2017.
SLIDE 17: IRC 168K: BONUS DEPRECIATION
-Used property now qualifies for bonus
-NOTE: the effective date is September 28, 2017 for property acquired and placed in service.
-The applicable bonus rate is 100% (instead of 50%) for assets acquired and placed in service after September 27, 2017 and before January 1, 2023.
-Phase outs will begin in 2023
-2 Major changes are that used property can now be used and it changes from 50% to 100%)
SLIDE 18: BONUS DEPRECIATION
-The taxpayer may elect to utilize the 100% or 50% bonus rate.
-Normally, it applies to assets in the 3,5,7,10,15 and 20-year life depreciation categories.
-Bonus depreciation is not allowed for property placed in service and disposed of during the same taxable year.
SLIDE 19: BONUS DEPRECIATION CHART
-Longer depreciation life, shorter depreciation expense.
SLIDE 20: IRC 199A – DEDUCTION OF QUALIFIED BUSINESS INCOME OF PASS THROUGH ENTITIES
-Does this apply to you? Check with your tax advisor.
-There was massive change to corporate tax rates. So companies started to re-evaluate their business structure. Do you want to do the 100% Bonus depreciation if you have some deduction available through pass through.
SLIDE 21: NET OPERATING LOSSES
-Under the new law, a Net Operating Loss can offset only 80% of taxable income in any given year. If you have losses, they can roll forward, but can only offset 80% of your income.
SLIDE 22: DEPRECIATION TAX PLANNING: MORE CRITICAL THAN EVER.
-Timing of your Cost Segregation Study – Lookback vs. Year of Purchase
-168K Bonus Depreciation – 100%, 50%^ or 0%
-163 (j) interest expense Limitations and Impacts
-Depreciation Methods and Depreciable Lives
-NOL Carry forward rules.
SLIDE 23: SELECTING A COST SEGREGATION COMPANY
-Ensure firm has both engineers and tax accountants devoted exclusively to Cost Segregation Studies.
-Dual In-house focus identifies issues often overlooked by firms with accountants and engineers who operate independently.
-Ensure Feasibility Study offers a true assessment based on thorough review.
-Inquire about actual IRS audit and defense experience.
SLIDE 24: COST SEGREGATION STUDY DELIVERABLES
Phase 2: Execution and Study
-Contemporaneous documentation for IRS.
—Follows process and methodologies outlined in the IRS Audit Technique Guide.
—Reports are valuable backup for CPAs’ tax filings and are IRS field-audit tested.
-Turnkey approach for 481(a) calculation (for Look-Back study).
-File IRS Form 3115 Change in Accounting Method
SLIDE 25: CLOSING STATEMENT
-A Cost Segregation Study creates an income tax benefit for investment properties or for any other income generating properties.
QUESTION: DO YOU INVEST IN OPPORTUNITY ZONES?
-Kenny does not. Opportunity zones are attempts to revitalize deteriorated areas. Why Not? If it has not gentrified enough, or you cannot buy enough of the property to change the neighborhood, be careful.
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