Circ Cost Segregation

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Cost Segregation: What Every Investor Should Know My Mission: Provide quality financing alternatives to individual and business clients with the highest degree of service by practicing honesty, integrity, and sound business ethics in enabling long-term relationships and successful problem solving when it comes to my clients’ real estate concerns. The highest compliment that I can receive is the referral of your family, friends, and colleagues. Thank you! Dan Email: [email protected] Office: (573) 234-4886 Fax: (866) 403-8248

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Cost Segregation Studies, IRS

Transcript of Circ Cost Segregation

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Cost Segregation: What EveryInvestor Should Know

My Mission:

Provide quality financing alternatives to individual and business clients with the highest degree of service by practicing honesty, integrity, and sound business ethics in enabling long-term relationships and successful problem solving when it comes to my

clients’ real estate concerns.

The highest compliment that I can receive is the referral of your family, friends, and colleagues. Thank you!

Dan

Email: [email protected] Office: (573) 234-4886 Fax: (866) 403-8248

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Why You Need to Know

Cost Segregation (CS) is a strategic approach to maximizing investment cash flow for property owners who have built, purchased, added to, or

remodeled real estate.

CIRC has strategically partnered with Scarpello Consulting to provide you with the best study possible. Our approach is designed to maximize your depreciation while minimizing the risk of audit exposure. This is accomplished by doing more than properly classifying an asset as real or personal property; we clearly document how the values of the various component assets were identified. This includes identifying improvements on the building plans, quantifying the property using the most detailed level of cost information available, and describing the costing method employed.

About 40% of CPAs who have clients who invest in real estate know about cost segregation. Fewer have an in depth understanding. The proper segregation of costs requires the knowledge of construction costs and techniques as well as related tax law. Our team has extensive estimating, engineering, and construction experience permitting us to identify and quantify items of personal property accurately and in a manner acceptable to the IRS. Additionally, our experience in the real estate and construction industries provides a unique base of experience to take advantage of the taxpayer privileges provided by the IRC and reported regulations.

CS will maximize your net cash flow, increasing it as much as 20% or more, on current and future properties.

Adding a seller paid cost segregation study showing associated increased cash flow can significantly enhance the marketability of a property.

It’s not how much you make, it’s how much you keep. Cost segregation allows you to keep more by increasing your client’s net cash flow with accelerated depreciation.

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What is Cost Segregation?

There are four elements to any property:1. Land2. Land Improvements (i.e. fences and paving)3. Building4. Personal Property (Chattel)

The IRS allows qualifying items of land improvementsand personal property to be “segregated from thebuilding structure” for tax purposes.

Regulation § 1.167(a)-7(a) allows taxpayers to eitherdepreciate individual items on a separate basis or tocombine assets into group accounts and depreciatethe group account as a single asset.

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What is Cost Segregation?

Useful lives on the qualifying items can be depreciated over 5 and 7years for personal property and 15 years for landimprovements instead of 39 years for commercial buildings and 27½ years for residential buildings.

A cost segregation study segregates the costs and the useful lives ofthe individual property components. When the actual cost of eachindividual component is available, this is a more simple procedure.When only lump-sum costs are available, cost estimating techniquesare required.

The cost segregation study provides a new accurate depreciationschedule. The increased tax deductions that commercial propertyowners are legally entitled to take helps maximize property cash flow.

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What is Cost Segregation?

Cost segregation is a strategic tax savings tool that increases taxdeductions by accurately depreciating the land improvements andpersonal property.

In her Money Found article Angie Granger, CPA states "Costsegregation is one of the IRS' cash-flow secrets that CPAs,financial planners, real estate investment managers, and otherprofessionals can use to realize tax savings for their clients".

Cost segregation provides commercial property owners:

• Reduced Taxes• Increased Cash Flow• Maximized Annual Tax Depreciation• Increased Net Income• Reduced Property Taxes in Some States

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History

There are more than 75 IRS rulings, procedures and court caseswhich allow for cost segregation studies.

1997 Landmark decision - Hospital Corporation of America vs.Commissioner validates cost segregation, reinforcing the useof ITC methodologies and precedents as applicable todetermining depreciation.

2004 Cost Segregation Audit Techniques Guide is issued by theIRS to assist agents in reviewing cost segregation studies. Itprovides an understanding of the IRS’s point of view towardsparticular assets, defines various methodologies, and outlineskey components of a quality cost segregation study.

Did you know tax code to allow 1031 exchanges was first enacted in 1986? It took years for people to understand the tremendous benefit. Guidelines for Cost Segregation were published in 2004. Cost Segregation is very much coming of age as a savvy tax strategy.

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Current Guidelineshttp://www.irs.gov/businesses/article/0,,id=134180,00.html

Cost Segregation Audit Techniques Guide - Table of ContentsRevision Date December 2007

Table of Contents

Chapters:IntroductionLegal FrameworkCost Segregation MethodologiesPrincipal Elements of a Quality Cost Segregation Study and ReportReview and Examination of a Cost Segregation StudyAppendix

Uniform Capitalization Change in Accounting Method Depreciation Overview Relevant Court Cases Statistical Sampling Construction Process Information Document Requests

Industry Specific Guidance Casinos Restaurants Retail Industries Biotech & Pharmaceutical Industry Auto Dealerships

While most of the Guide is ratherdry, you might find the itemsclassed as personal property in theindustry specific guidance aninteresting read.

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Qualifying Assets

Useful lives on the qualifying items can be depreciated over 5 and 7years for personal property and 15 years for landimprovements instead of 39 years for commercial buildings and 27½ years for residential buildings.

The most widely used lives are:

5-Year and 7-Year PropertyIRC §1245 Tangible Personal Property

15-Year PropertyIRC §1250 Building Components

27.5-Year Property (residential building)

39-Year Property (non-residential building)

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Qualifying AssetsTangible Personal Property – 5 & 7 Year Useful Lives

• Specialty plumbing, lighting and associated wiring (20%-50%)• Booths, lockers, benches, counters, kiosks, office furnishings.• Decorative mill work and removable wall coverings.• Carpeting, floor coverings, and window accessories.• Equipment for climate controlled rooms.• Computerized sales systems, surveillance, music and PA system.• Signage, some canopies, and awnings.• Non-permanent, moveable walls and partitions• Restaurant décor, eliason doors, drive through equipment,

kitchen HVAC, kitchen equipment hookups, beverageequipment, etc.

The Accounting Rule for Personal Tangible Property is200% Double Declining Depreciation

You get the biggest cost segregation bang for your buck is in the first 5 to 7 years due to the tangible personal property write-offs. Because most commercial property owners typically turn their properties every 5 to 7 years, they should always be taking advantage of cost segregation.

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Qualifying Assets

Land Improvements and Other 15 Year property

• Driveways, sidewalks, parking lots, and pole mounted lighting.

• Landscaping, gardens, and fences.

• Pylons and footings for light poles, signs, and canopies.

• Stonework imbedded in the ground or applied to exterior.

The Accounting Rule for Land Improvements is150% Declining Depreciation

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Other Benefits

A Cost Segregation study provides a taxpayer with information needed to take bonus deprecation and IRC §179 deductions.

Component Replacement DeductionIf a building component subsequently needs replacement, taxpayers can write off its remaining tax basis.

To illustrate, suppose a cost segregation study showed the initial value of a roof to be $500,000. Two years later, when the roof has an adjusted tax basis of $480,000, it needs to be replaced. The taxpayer could write off the entire adjusted tax basis and deduct a $480,000 loss. This is a great capability to have with older properties.

Cost segregation may result in lower local real estate transfer taxes. Localities often impose these taxes based on a building’s fair market value. When a cost segregation study reduces a building’s value, this produces a corresponding reduction in the amount of the transfer tax due (and a potential reduction of annual real estate taxes as well).

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Rehab Tax Strategy

If a property is going to be gutted and rehabbed, getting a cost segregation study completed before gutting establishes the value of all non-building components. Once the property Is gutted, the non-building components can be written off in full.

$2,000,000 office building x 25% personal property = $500,000 write-off

When the property rehab has been completed, a new cost segregation study establishes the new accelerated depreciation schedule for increased cash flow.

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Cost Segregation Candidates

• Properties with more than $750,000 in buildings and tenant

improvements.

• Owner plans to keep building for 3+ more years

• Owned by individuals or for-profit entities paying taxes

• New or existing buildings

• All types of commercial properties and apartment buildings.

• Special use structures – i.e. medical buildings, franchise

operations, car washes, car dealerships, etc.

• Property acquired by owner after 1986.

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Cost Segregation Candidates

Average Percentage of Property Reallocated to 5, 7, and 15Year Depreciation with a Cost Segregation Study

Property Type Percentage Reallocated

Manufacturing Facilities 30-70% Golf Courses 30-50%

Medical Facilities 25-43% Banks 25-43% Restaurants 23-40% Grocery Stores 27-40% Hotels 20-40% Auto Dealerships 20-35% Retail Stores 10-40%

Apartments 20-30% Offices 12-25% Warehouses 10-17%

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Cost Segregation Candidates

Leasehold improvements can also qualify for a Cost SegregationStudy. Interior build-outs generally produce a proportionally higherratio of qualifying property. Therefore a Cost Segregation Study thatanalyzes the costs of leasehold improvements can be even morebeneficial.

A cost segregation study on leasehold improvements is sometimescalled a tenant improvement study.

Determining the feasibility of a tenant improvement study requiresreviewing the lease to understand who owns the assets andtherefore will be depreciating them. When costs are shared andthere is a landlord contribution things get a bit more complicated.

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Feasibility Considerations

Passive Loss

Taxpayers with multiple properties can often qualify as a real estateprofessional enabling them to offset other income with lossescreated by the added deprecation realized by a study.

Taxpayers who spend 15 hours per week (750 hours per year)materially participating in real property are generally able to beconsidered real estate professionals per IRC.

If the owner leases the building to a business that they own andmaterially participate in, if by leasing the building to the business atthe highest possible rental FMV you generate more rental income,additional depreciation will benefit to the extent of that income.

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IRS GuidelinesOf the 13 essential elements of a quality cost segregation study,the very first item the IRS lists is

“Preparation By An Individual With Expertise And Experience.”

“The preparation of cost segregation studies requires knowledge ofboth the construction process and the tax law involving propertyclassifications for depreciation purposes.”

“However, the possession of specific construction knowledge is not theonly criterion. Experience in cost estimating and allocation, as well asknowledge of the applicable law, are other important criteria.”

“A quality study identifies the preparer and always references his/hercredentials, experience, and expertise in the cost segregation area.”

Some accounting professionals will perform cost segregation studies. Unless they have specific construction knowledge, they do not meet the very explicit IRS requirement of an individual with expertise and experience. The cost segregation studies SC has reviewed that were performed by CPAs missed 50% to 60% of the allowable deductions because the CPAs didn’t understand the construction process and didn’t know what was inside the walls.

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Depreciation Comparison

Again, the biggest bang for thebuck is in the first 5 to 7 years.Because most commercialproperty owners typically turn their properties every 5 to 7 years, they should always be taking advantage of cost segregation.

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New Shopping Center

Assuming a 9% cap rate, the 2007additional benchmark tax savings of$297,564 increases cash flow by 16%.Assuming a cap rate of 7%, the increaseis almost 20%.This tax savings of almost $300,000 isCASH in the owner’s pocket in 2007.

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Nevada Professional Plaza

Assuming a 9% cap rate, the benchmark 2008 additional tax savings of$234,959 increases cash flow by 22%.

Assuming a cap rate of 7%, the increaseis almost 27%.

The almost quarter of a million dollars is extra CASH in the owner’s pocket in 2008.

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Medical Development

The benchmark 2007 additional taxsavings of $237,829 reflects catch up depreciation (increases cash flow, assuming a 10% cap rate, by 31.6% in 2007).

Again, the almost quarter million dollars is CASH in the owner’s pocket in 2007.

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Cancer Center - Antioch

The benchmark tax benefit in 2008 of$154,371, assuming a cap rate of 10%, increases 2008 net income by 26.44%. The $154,371 is additional CASH in the owner’s pocket in 2008.

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So. California Hotel

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How to Get StartedRequest a complimentary Cost Segregation Benchmark Study

WE NEED TO KNOW:1. Date of Ownership / Property Transfer Date2. Cost of Commercial Property (Excluding Land)3. Type/Use of Building (Medical Center, Office Building,

etc.)4. Size of the Building(s) (sf)5. Current Depreciation Schedule (for property purchased

in prior years)6. Capital Improvements – Type/Date/Cost7. Current Tax Rate (if available)

You will receive a benchmark study, NPV analysis, and fee proposal to perform the engineering study.

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Then What Happens?

Owner signs engagement letter and pays an agreed upon engagement fee.

Owner Provides Building Documentation(appraisal, depreciation schedule, blueprints, G702, G703, etc.)

CIRC and SC then:• Inspects and photographs the property to document the classification of capitalized

costs into their appropriate class lives.• Reviews all cost details and available blue prints.• Reconciles all construction costs.• Uses trending estimates to account for location, time, and physical condition.• Reviews for allocation of soft costs to any direct cost.• Make a determination regarding proper tax life and recalculate depreciation and the

applicable 481(a) adjustment (prior year purcase)• Prepare and draft Form 3115. (prior year)• Prepares the final report with supporting documentation on CD.• Provide road map for future purchases.

Typical Engagement Letter period 30-60 days, Final Report is typically 6-8 weeks.

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Cost Segregation Summary

• Cost Segregation is the IRS approved method of re-classifying components and improvements of a investment property to allow accurate depreciation of the property.

• Applicable to both owners and leaseholders. Feasibility needs to be determined on an individual case basis.

• The net result creates significant acceleration of available tax deductions.

• Traditionally Big 4 CPA firms and National Appraisal firms with engineering departments have used cost segregation with their large clients. Economies of scale have prevailed and the tax benefit is available to most investment property owners.

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Cost Segregation Summary

While most accountants and commercial real estate practitioners haverudimentary understanding of using cost segregation to increasedepreciation and decrease federal taxes, many overlook the process because

of a misunderstanding of cost or financial feasibility.

The execution rate for cost segregation is less than 10% becauseof limited knowledge regarding the cost of a survey and the sizeof properties for which cost segregation studies are financiallyfeasible.

IRS favorably supports cost segregation to allow payment of less tax in early years of the investments. Many real estate investors are

unintentionally overpaying federal income taxes. In addition, theyare paying federal income taxes earlier than necessary.

A seller paid cost segregation study can be a great sales incentive.

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Why CIRC & SC?

Our studies comply with the IRS standards stipulated in the Audit Techniques Guide for Cost Segregation Studies.

SC completes a complimentary review of the results of a fully engineered study. Net Present Value analysis usually shows at significant benefits to cost ratio.

SC has a team of engineers on staff as well as tax professional with specialized expertise in cost segregation to answer technical questions when needed.

Combine the study with CIRC financing alternatives to maximize the leverage of your investment.

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Contact Information

For Additional Information or aNO-COST, NO-OBLIGATION

Cost Segregation Benchmark Review

Daniel PeeryCommercial Investment Research Center

Office: (573) 234-4886Fax: (866) 4038248

[email protected]

My Mission:

Provide quality financing alternatives to individual and business clients with the highest degree of service by practicing honesty, integrity, and sound business ethics in enabling long-term relationships and successful problem solving when it comes to my

clients’ real estate concerns.

The highest compliment that I can receive is the referral of your family, friends, and colleagues. Thank you!

Dan