Cost Segregation

One of the great advantages of commercial property investing is the tax benefits. The IRS has a program that allows the owners of apartment buildings or any other commercial property to increase the level of accelerated depreciation allowed in a tax year.

The tax savings may go back to property acquired after 1986, and they apply to new or future construction. They also extend to existing buildings under renovation, expansion and leasehold improvements, as well as to property about to be acquired. It can also be used for financial accounting, insurance and property tax purposes. The primary goal of a cost segregation study is to identify all construction-related costs that qualify for accelerated income tax depreciation. Cost segregation is not a tax shelter and it is not tax evasion.

Ask Yourself These Questions To Determine if You and Your Property Qualify:

Do you own a commercial property valued at $500,000 or more?

Do you pay federal income taxes?

Do you operate a corporation or entity that is for-profit?

Are you planning to the hold the property for more than one year?

To Obtain the Benefits of Cost Segregation You Must Get a Study

Your cost segregation study will analyze the taxes and costs incurred to buy, construct or renovate any kind of commercial real estate. You will need to procure the services of an expert or CPA to conduct the study. The CPA will dissect the costs to determine the accelerated income tax schedules. In order to meet the minimum qualifications of a cost segregation study, property owners must be taxpayers or intend to pay taxes. The cost of a study can range between $10,000 and $100.000.00 depending on the size and complexity of the project.

Advantages of Cost Segregation

• Considerable return on investments property that do not need to be insured.
• Increased tax deductions for depreciation and reduces taxable income.
• Opportunity to correct misclassified assets and claim “catch-up” tax deductions.
• Ability to achieve faster building and acquisition cost write offs.
• Reduction in insurance costs by identifying the components of the property that do not need to be insured.
• Determine personal property versus real property for write off versus capitalization prior to construction. This allows you to write off these items opposed to capitalizing the assets. This can provide you with huge tax benefits.
• Defers taxes on capital gain amounts until the property is sold.
• Reduces real estate property taxes.
• Reduces federal income tax and increases depreciation.

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This Post is from the BiggerPockets Real Estate Blog. Copyright © 2008 BiggerPockets, Inc. All Rights Reserved.

Apartment Building Cost Segregation Analysis

The apartment building investor should always be aware of the amount of money that he or she has invested in an apartment building and more importantly the “time value” of that money. This concept of money’s value over a period of time becomes extremely important when comparing and contrasting different apartment building finance strategies. For example, the investor may want to evaluate an offer to buy his apartment building by another investor who requires that he offer owner financing. When offering the sale of an apartment building with an owner held note, the seller has to figure out what the value of the mortgage payments, over a specified period of time would be equal to in today’s dollar. The investor/owner must make these calculations so that he or she is able to compare the purchase offer to other offers which differ in terms. To figure out how the time value of money will effect investment returns the apartment building investor must determine what the “present value” and the “future value” of the money invested is and will be.

For example, an investor considering the purchase of an apartment building with an asking price of $1,000,000.00. The investor believes that the property should appreciate by about 5% over the next five years and he wants to figure out what the value of the “future value” of the property will be after five years based on this assumption. Even for the beginning apartment building investor it is important to learn how to make some important mathematical calculations when determining the value of different potential apartment acquisitions.

Scenario: The investor is considering the purchase of an apartment building. The owner is asking $1,000,000.00. The investor expects that the apartment building investment will increase in value by 10% annually. Or, each year the value the apartment building will increase at the anticipated 10% on the principal and on any interest previously earned.

To figure out what the future value of the apartment building property will be, the investor must know the following figures:

Present value =                    $1,000,000.00
Future value (unknown) =           unknown
Return rate=                       10%
Time length=                       3 years

We don’t know the future amount, but we can easily find it.

Let today be time zero, when the apartment building is worth $1,000,000.00

Let’s put this process on a time line to see how the value of the land increases over three years:

0                    1
1,000,000  1,000,000(1+.10) 

2                                     3
1,000,000(1+.10)(1+.10)  1,000,000(1+.10)(1+.10)(1+.10)

Thus, the value of the land at the end of year three can be found by:
1,000,000(1+.10)(1+.10)(1+.10) = $1,191,016.00

or, equivalently,

1,000,000(1+.10)³ = $1,191,016.00

This leads us to the formula for the Future Value of a lump sum:
FV = PV(1+i)ⁿ

Here, PV = present value or amount, i=interest rate, n = length of time.

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This Post is from the BiggerPockets Real Estate Blog. Copyright © 2008 BiggerPockets, Inc. All Rights Reserved.

Apartment Building Investment and the Time Value of Money