Why every commercial real estate agent should be familiar with the accelerated tax depreciation tool?
Recently I was hired to appraise a commercial office building in Tampa during the due diligence period. The buyer wanted to make sure the improvements were valuable enough to be eligible for a substantial improvement. Because the building is located in a flood zone, FEMA regulations allow only 50% of the depreciated market value of the “sticks and bricks” to be used for major remodel or additions.
During the inspection I noticed the elaborate interior built-out and the respectable amount of site improvements. I suggested to the client to perform a cost segregation analysis as soon as he will have closed on the building. Because the buyer was a seasoned investor, I assumed he was familiar with this great tax depreciation tool. Well, obviously not.
So here was my explanation for him:
When commercial buildings like hotels, restaurants, office buildings, medical offices, etc. change hands the depreciation is set back to zero for the new owner. The owner can add the cost of sale (settlement charges, etc.) to the sales price, deduct the land value and depreciate the remaining amount over the period of 39 years, meaning every year he will deduct 1/39th of the sales price minus the land from his gross income.
However, when an analyst like me performs a cost segregation analysis on the building the depreciation can be accelerated at a high rate, and here is how it works:
The interior built-out like cabinetry, base boards, crown molding, window sills, carpet, countertops, appliances, light fixtures, security systems, communication systems, percentage of electric work, in medical offices even plumbing (e.g. medical suction system) are segregated out of the building as 5-year and 7-year depreciable property. Furthermore, the site improvements like site prep, paving, concrete curbing, wheel stops, landscaping, irrigation, lighting, backflow preventers, pools, etc. will be segregated as 15-year depreciable property.
The residual is the remaining 39-year depreciable property, the actual sticks and bricks. So instead of depreciating 1/39th for 39 years, the owner can depreciate a certain percentage of the sales price in 5, 7 and 15 years.
In hotels for example we usually can segregate about 20% to 30% as 5-year and 7-year property and another 20%+ as 15-year property. Following is an Excel spreadsheet showing the depreciation process in a simplified layout. It is a little more complicated to apply the correct MACRS tables, but for the purpose of this blog, I want to keep it simple:
So just for the first year the commercial property owner can depreciate $152,211 more if the building receives a cost segregation analysis. This amount will be repeated for four years, after that the amount goes down to include only the 7-year, 15-year and 39-year property and after the seven years it will only include the 15-year and 39-year property, etc.
I think you all got the basic picture, right? The savings are incredible. And I can’t believe how many people I run into in the commercial real estate circus who have no clue that this IRS tax depreciation tool exists.
Do you, commercial real estate agent, believe that cost segregation is a selling tool? Trust me, in many cases this knowledge seals the deal!
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