So April 15th has come and gone. No, you’re not checking your account to see if the IRS has deposited your tax refund and you didn’t take your W-2 to Lucky Larry’s Used Cars to drive off for $99.00 a month for 139 months. If you are like the majority of business owners, commercial real estate (CRE) owners and investors you signed your extension and wrote a BIG check to Uncle Sam….your CPA will figure out the details later.
Why did you initially invest in CRE instead of throwing $$$ in the stock market? Cash flow, wealth building, favorable tax treatment? Of course! I mean really, everyone knows you can’t depreciate your Apple stock now can you? Besides, you get to depreciate your building over 39 years or, for my apartment investor friends, 27.5 years. That means if you paid $1,000,000 for an office building, the IRS generously lets you realize the fruits of straight line depreciation in the amount of $25,641 annually for the next 39 years! Not bad, huh?
Oh…ok so the IRS is giving you $25,000 annually (close enough for government work) for owning CRE? $25,000 of their money? HELL NO! That’s YOUR money!! But they are paying a good interest rate, right? As of Q2 2019, they are charging you 6% interest plus penalties if you owe them. You would think they could at least be nice enough to cover inflation at 2% or so, but noooo. Drunk Uncle Sam is using your money to fund, among other things, a $30,000 production of Doggie Hamlet with a cast of dogs, sheep, and humans. (I can’t make this shit up, Google it if you don’t believe me).
Don’t get me wrong, CRE provides tax benefits and returns that no other asset class does and a record number of investors are placing hundreds of billions of dollars in CRE. But how can you get more of YOUR money back NOW? If you are familiar with the time value of money concept, please move on to the next paragraph. If not, click the blue letters in the previous sentence.
The smart folks running a couple of companies named HCA (Healthcare Corporation of America) and Walgreen’s decided that the idea that every component in a building is created equally and will last 39 years was utter bullshit (ever tried to purchase some of that 39 year carpet?). They started accelerating the depreciation of components in their properties that in no way had a 39 year useful life and began applying the actual useful life to these items.
The IRS didn’t agree and, in HCA’s case, sent them an $800,000,000 bill. Yes, Eight Hundred Million Dollars! HCA sued the IRS (HCA v. Commissioner) and won. Beat the IRS! Who does that? Anyway, that case created what is now known as cost segregation.
So, what is this cost segregation and how does it apply to you, the commercial real estate owner/investor? The IRS now allows allocating components of a building into 5, 7, 15, and 39 year useful life by using an engineering based study. So, that $50,000 worth of flooring in your building is now identified as a 5 year component and allows the depreciation of $10,000 a year for 5 years instead of $1,282 over 39 years. And this process is applied by engineers for every component of the building. Makes sense, right? Do I have your attention now?
So what is the cumulative effect of this process? What does this mean to you, the owner/investor who put your ass on the line, signed on the dotted line (don’t forget that personal guarantee!) and celebrated with a bottle of wine?* How about 6% to 10% of the cost of your building? Yes, that’s right! $60,000 to $100,000 for every $1,000,000 of building cost. Hell, from what I hear, the savings on a $3,000,000 building alone will get your kid into the college of your choice, just ask Aunt Becky!
And then there is the Tax Cuts and Jobs Act of 2017. You know, the one everyone on the news is talking about? Well, I’ll let you in on a little secret called 100% Bonus. If you acquired or built any CRE or multifamily properties in 2018 and HAVE NOT filed your 2018 taxes and extended, those 5,7 and 15 year components are all taken in year 1!
What does this mean for you? Well, for example, a client of mine in Tennessee just built a building for $2,000,000 summer of 2018 and he is getting just over $175,000 back this year rather than the $51,000 they would have received using the straight line depreciation method. I didn’t go to Harvard, but that’s somewhere around an extra $124,000 in their pockets NOW! That’s real money, and what are they going to do with it? Build or buy another building! They could also take this savings and apply to past due taxes or carry it forward for 2 years. Imagine not writing that quarterly check for a while! Stop enabling you drunk uncle!
Some will say, what about the depreciation I won’t get in future years? To those I say, click the blue letters in paragraph 4.If you would like to learn more, or would like a no cost estimate of your potential tax savings you can reach me here: dsebastian@ccim.net, @donccim, LinkedIn
*I really meant bourbon, just didn’t rhyme.
Don Sebastian, CCIM 