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Tax Saving Strategies Cost Segregation Studies for Commercial and Residential Rental Properties.

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Presentation on theme: "Tax Saving Strategies Cost Segregation Studies for Commercial and Residential Rental Properties."— Presentation transcript:

1 Tax Saving Strategies Cost Segregation Studies for Commercial and Residential Rental Properties

2 What is Cost Segregation? Smart tax strategy for commercial and residential investment property owners Allows property owners to access taxpayer- friendly changes to tax law Property owners find a friend in the IRS

3 Goal of Cost Segregation Studies Free up money trapped in the walls of the building per the IRS Audit Technique Guidelines Goal = to identify all construction-related costs that can be depreciated over 5, 7 and 15 years and reclassified from 39, 31.5 and 27.5 years Traditional depreciation for Real Property is 39 years for commercial property and 27.5 years for residential rental property Personal property is depreciated much quicker and can be depreciated over 5, 7, 10, and 15 years Reducing tax lives results in accelerated depreciation deductions, a reduced tax liability, and increased cash flow

4 The Time Value of Money – Win the money game! Albert Einstein is quoted as saying: "compounded interest is the 8th Wonder of the World - It can work for you, or against you. When you retain it, it works for you. When you borrow it works against you! Learn To Master The Compound Interest Calculations Now look at what happens to your money each time it doubles... $1... $2... $4... $8... $16... $32... $64... $128... Win The Money Game! Leverage old money you are already spending to create new money you can invest. By lowering your tax payment you free up cash, which you can then invest. Your goal is to have compound interest work for you and not against you.

5 Defer, Defer, Defer As Benjamin Franklin said, "In this world nothing is certain but death and taxes." While both death and taxes may be inevitable, we are constantly challenged to figure out a way to defer both. The potential value of deferring taxes is one of the primary reasons there is such a growing interest in cost segregation.

6 Free-up Trapped Money Traditional depreciation for Real Property is 39 years for commercial property and 27.5 years for residential rental property Personal property is depreciated much quicker and can be depreciated over 5, 7, 10, and 15 years

7 What Are The Benefits? Generates immediate increase in cash flow through accelerated depreciation deductions Reduces income taxes and real estate property taxes Provides an easy opportunity to claim “catch up” depreciation on previously misclassified assets Provides an independent third-party analysis that will withstand IRS review Benefits Bank Loan Qualifications

8 Seizing Tax Savings Identify the parts of a building that qualify as personal property and depreciating these parts separately from the rest of the property Accelerates federal tax depreciation on segregated components, reducing current income tax payments and increasing net cash flow

9 Additional Benefits Pre-Construction Planning: In the design phase, Cost Segregation can help make the building more tax efficient by identifying business components from the structural components Property Tax: Property taxes are calculated as a percentage of the building costs. In any real estate investment, personal property should be accurately removed from the cost of structural components and not to be recorded as part of the property tax Insurance Company: Cost segregation can identify the cost of non insured properties, and therefore reflect more accurately of the insurance covered properties and reduce the insurance cost

10 Additional Benefits Real Estate Investment Trusts (REITs) May identify up to 30% of their building’s component costs as tangible personal property qualifies for accelerated depreciation Can substantially increase depreciation charges provides increased cash flow for additional acquisitions

11 Additional Benefits Demolition/Rehabilitation Ability to identify components of a building prior to demolition/rehabilitation which can be reclassified as personal property versus real property Allows the owner to write off these items versus capitalizing the assets which generate a substantial tax savings

12 Additional Benefits Not For Profit Corporations n Increase depreciation expense for book reporting purposes which allow the retention of cash versus distributions to members

13 Items To Be Accelerated Site Improvements (landscaping/parking) Light Fixtures Branch wiring Potential Plumbing Flooring Millwork Millwork Window Coverings Partition Walls Cabinetry Furnishings Shelving Wall Coverings Irrigation Systems Items which can be reclassified include:

14 Items To Be Accelerated Factors that now govern whether property is permanent or can be reclassified: Permanency test - Sec. 1.48-1 (c) Is the property capable of being moved? Has it been moved? Is the property designed or constructed to remain permanently in place? Are there circumstances which tend to show the expected or intended length of affixation - i.e. may or will be moved? How substantial of a job is removal of the property & how time consuming? Is it readily movable? How much damage will the property sustain upon removal? What is the manner of affixation of the property to the land?

15 Qualified Property Primary and Secondary Electrical Distribution Systems Property to include: Main panels Motor control centers Transformers Main distribution panel switchgear Related wiring and conduit The courts conclude that the portion of the cost of the primary and secondary electrical distribution systems which is equal to the percentage of the electrical load carried to those systems allocable to the property equipment, as stipulated constitutes the 1245 qualification class property and is depreciable over an accelerated life.

16 Qualified Property Branch Electrical Wiring and Connections, and Special Electrical Equipment Property to include: Controls Battery packs Battery chargers for emergency power equipment Illuminated emergency and entrance signs Medical gas control and alarm equipment Kitchen equipment Wired clock systems Normally 100% of the load carried relates to this type of equipment, therefore the balance of the electrical is normally allocated to the building

17 Qualified Property Wiring and related Property Items Relating to Television Equipment Property to include: Branch electrical wiring Conduit, floor boxes Junction boxes Outlet receptacles All other equipment in connection with its operation

18 Qualified Property Electrical Wiring Relating to Internal Communications Property to include: Conduit Wiring Electrical connections Systems supported: Call systems Intercommunication systems Dictation systems Music systems Paging systems

19 Qualified Property Carpeting Carpeting is normally custom fit Installed over the sealed concrete floor using adhesives Not permanent or re-used Quick removal with little to no damage to the underlying structure Income tax Reg. Section 1.48-1(e) (2) does not list carpeting as a structural component nor as an integral part of the floor itself

20 Qualified Property Vinyl Wall Coverings Vinyl wall coverings are not intended to remain as a permanent or integral part of the structure Can be easily removed Applied using adhesive which is expressly recognized as being non-permanent Are decorative in nature The adhesive rule is the catch – S. Rept. 95-1263, 1978-3 C.B. (Vol. 1) at 415 specifically states that items adhered to a surface using stripping adhesive are non-permanent

21 Qualified Property Vinyl Floor Coverings Vinyl floor covering and matching base cove molding is also attached by using adhesive Subject to Section 1245 property depreciable over accelerated recovery periods Pursuant to S. Rept. 95-1263, 1978-3 C.B. (Vol. 1) at 415

22 Qualified Property Kitchen Plumbing Property to include: Items relating to operation of grease trap systems Trench drains Grease waste piping Waste excavation Waste fill Trap itself All connections (hose and reel connections) Water piping used for operation of kitchen equipment

23 Qualified Property Kitchen Hoods and Exhaust Systems Property to include: Air intake fans & related duct work Dishwasher condensate return units These items ventilate air, remove humidity and steam, replace air expelled Test: Do the items relate to the buildings operation or maintenance? NO! Therefore are considered Section 1245 property

24 Qualified Property Partitions Property to include: Accordion-style room dividers Decorative lattice millwork used to separate areas These items are not permanent structures therefore do not affect the operation nor maintenance of the building 1245 property

25 CSS Brief History Cost segregation studies began during the 1980's as a means to help developers of new property obtain special investment tax credits for personal property contained in the buildings In 1997, the US Tax Court ruled in favor of Hospital Corporation of America (HCA), that property qualifying as tangible personal property under the former ITC rules would also qualify for purposes of federal income tax depreciation. HCA is considered a landmark decision for owners of commercial properties In 1999, the IRS released Legal Memorandum 19921045 in which the IRS agreed not to contest the (HCA) reclassification of building costs into different asset categories that result in shorter depreciation lives This legal memorandum directs agents to verify that an engineering or architectural study has been done to identify portions of the building's system not related to the operation and maintenance of the building. Without these detailed studies, IRS agents are advised NOT to accept the reclassifications

26 Myths of Cost Segregation “Why hasn't my accountant told me about Cost Segregation?” Most CPA firms do not have experienced cost segregation or partner with engineers and architects to physically inspect the property, examine architectural/engineering drawings and analyze cost data. Without engineering expertise, clients will often miss substantial portions of a building to achieve tax savings. Cost Segregation is a cutting edge tax saving strategy. We carefully follow new tax laws in this area We have partnered with Quantum Engineering Associates Inc.(QEA) to offer CSS to our clients.

27 Myths of Cost Segregation “Will a cost segregation study raise suspicion with the IRS?” Engineering-based cost segregation studies to classify depreciation are an accepted standard approved by the IRS Our experience in conducting successful cost segregation studies means your report will withstand IRS scrutiny F&D/QEA team is experienced in segregating costs and applying judicial decisions, IRS rulings and regulations to your situation

28 Myths of Cost Segregation “Why do we need an Engineer in our team?” Without the contractor/engineering expertise coupled with the CPAs tax law guidance, there will likely be valuable tax benefits left on the table Without a complete Engineering and Tax Law study the depreciation changes will not withstand IRS scrutiny in accordance with the IRS Audit Technique Guidelines

29 Myths of Cost Segregation “We'll get the deduction in the future anyway, without a cost segregation study...right?” You can have the cash now for investments or to meet current needs. The present or future value of money is usually substantial Yes, but a cost segregation study gives you an interest free loan from the government for the first 15 years, which you will then repay interest free over the remaining 25 years. Who do you want holding your money?

30 Myths of Cost Segregation “I’ll owe taxes when I sell the building” Taxes are due when a property is sold, except with CSS, your deduction will not be at ordinary rates and a majority of the taxes due will be at capital gain rates. This can result in a lower tax rate difference of 16% at the highest marginal tax rates.

31 Myths of Cost Segregation “I am out of luck because the building was constructed or acquired in prior years” Special provisions enacted by the IRS allow you to “catch-up” on any missed depreciation for any buildings built or acquired since 1987

32 Do I Qualify? You would benefit from a cost segregation study if you… Constructed your buildings and facilities since 1986 Acquired your buildings and facilities that were constructed before 1986, but acquired in a taxable transaction after 1986 Renovated your building after 1986 Made additions to your buildings after 1986

33 Who Can Benefit Airport Hangars Apartment Buildings Automobile Dealerships Automobile Service Centers Banks Restaurants Day Care Centers Department Stores Distribution Centers Fitness Centers Industrial Hospitals Hotels Laboratory/Research Facilities Manufacturing and Processing Facilities Marinas Medical/Surgical Facilities Nursing Homes/Assisted Living Facilities Office Buildings Post Office Resorts Restaurants Shopping Center Warehouses Properties with the highest savings potential include:

34 Cost Segregation Results Project: 25 Apartment Complexes Cost: $188,100,000.00 Net Present Value Savings: $10,585,222 Project: Assisted Living Facility Cost: $5,234,125 Net Present Value Saving: $625,678 Project: Hotel Cost: $7,123,456 Net Present Value Savings: $812,145 Net Present Value assumes a 39 year holding period, a 5% discount rate and a 35% tax rate

35 Example Mortgage Pay-down Illustration The cost basis of the property is $10,000,000 The Net Present Value Savings is projected to be approximately $1,002,973 The cost to recapture your tax dollars now being held at the IRS is: 3.2% Put another way, the return on your times over 10 years, the investment is: 31.3% The annual interest rate required to grow an investment to that level is: 46.8%

36 Example Mortgage Pay-down Illustration Continued… If you applied the yearly tax savings to pay down the current mortgage, you could save an additional $2,051,424.00 in mortgage payments over the term of the loan You could also eliminate 4.3 years of mortgage payments This savings is derived from having not to make 51 mortgage payments of $59,278 each

37 Example Investment Illustration If you invested the tax saving annually at 5%, the savings would grow from $196,510.00 to $1,418,623.00 over the next 10 years

38 Froehlich & De La Rua Firm Advantage We have partnered with Quantum Engineering Associates, Inc who Specialize exclusively in cost segregation services since 1989. We have experience with cost segregation cases with assets over $50M We take a rigorous engineering and architectural approach, the very type of approach approved according to the IRS Guidelines

39 Froehlich & De La Rua Firm Advantage Driven to unearth the most opportunities for tax savings on your behalf We prepare and deliver a thorough written report including spreadsheets segregating project costs into commercial/residential real estate, land improvement or personal property per IRS audit guidelines. We understand applicable Internal Revenue Code, Tax Court Rulings, IRS Actions on Decisions, Chief Counsel’s Advisories, Technical Action Memoranda, and other documents relating to depreciation of personal and real property

40 Summary Cost Segregation Benefits Dramatic deduction in taxable income Increased cash flow for investment opportunities and business expansion Property tax savings Insurance savings Real Estate Agents, Mortgages Brokers and Contractors can offer Cost Segregation option as a value added service Retention of $ in Palm Beach County from business owners in 2005 could reach $24,017,000

41 Contact Information P: (561)795-9500 / / Spanish & 12008 South Shore Blvd., Suite 210, Wellington, FL, 33414 Accounting Taxation Assurance Business Consulting Cost Segregation Studies for: o Commercial Real Estate o Residential Real Estate John F. Froehlich Betty De La Rua

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