BISON TALES - Bison Financial Group Newsletter

IRS Changes Help Apartment Owners Save Big Tax Dollars
By Philip A. Mann, CPA

1999 was a great year for people who own real estate, especially those who own apartment buildings. Why? For one, in an IRS legal memorandum issued in April 1999 the IRS finally acquiesced on allowing taxpayers to segregate various building costs into shorter depreciable lives other than the 27.5 years (via a process called a Cost Segregation Study). In addition, in another memorandum, the IRS acknowledged that personal property such as furniture and fixtures, and appliances should be depreciated over a 5 year recovery period and not 7 years as included in the instructions for Federal Form 4562 “Depreciation and Amortization.”

What Cost Segregation Studies are all about
Apartment buildings normally consist not only of land, bricks, and mortar, but such other items as land improvements (storm sewers, curbs and sidewalks, etc.) and personal property (VCT flooring, kitchen cabinets, etc.). While the brick and mortar are subject to a 27.5 year recovery period, land improvements qualify for a 15-year recovery period and personal property qualifies for a 5-year recovery period. If land improvements and personal property can be identified and segregated from the bricks and mortar, they can be separately depreciated over their shorter recovery periods. A Cost Segregation Study is the process for accomplishing the above. For an apartment building approximately 20%-30% of the total costs can be segregated into land improvements and personal property.

Sounds easy
Normally when someone purchases an apartment building, the only items broken out in the corresponding depreciation schedules are land (non-depreciable), buildings (27.5 year recovery period) and a nominal amount for personal property (5 year recovery period). Why? Because a qualified cost segregation professional was not hired to perform a study. If you have constructed a building, some additional items may have been broken out on the corresponding depreciation schedules as compared to a “purchased” building, but generally construction invoices alone are not sufficient to breakout land improvements and personal property to maximize accelerated depreciation deductions.

How an Apartment Owner Wins

Any apartment building purchased, constructed, or improved since 1987 is eligible for a Cost Segregation Study.
By accelerating depreciation, you lower your taxable income (or increase your loss) which saves you current year tax dollars, thereby increasing cash flow by the tax savings.
The net present value of the increased cash flow is about $200,000 for every $1 million of property that is reclassified to obtain faster deprecation. As an example, for a $2 million apartment building this would amount to approximately $100,000.
In most instances, it is not necessary to amend prior year tax returns. The change is prospective by filing Federal Form 3115 “Application for Change in Accounting Method” and there is no filing fee. Basically the amount of omitted depreciation from prior years is taken ratably as an expense over a 4-year period.
Your savings in most cases will be at least 10 times the cost of having a segregation study completed.

Things to be aware of

The IRS requires that a Cost Segregation Study be completed by a qualified professional such as an appraiser, engineer, architect, or construction estimator. A CPA is generally not qualified.
The IRS does not allow for breakouts based on percentages.

Conclusion

With personal maximum federal tax rates at a marginal rate of 41% and some state tax rates at 7%, a Cost Segregation Study is an extremely effective tool to lower taxable income without expending cash (except for the study fee). Think of it this way, you get to hold onto the government’s money for 15 years interest free and repay it over years 16 to 27 without interest. But don’t be fooled, isn’t it your money anyway? About the Authors Phil Mann, Managing Director at Cornerstone Business Services, LLC is considered a national expert in the field of cost segregation studies. His clientele includes large real estate developers, owners of single use buildings and many Certified Public Accounting firms throughout the United States. In addition to participating in hundred's of studies, he is a regular speaker at real estate and accounting seminars and has had numerous articles published in industry trade publications. For further information please visit Mr. Mann's website at http://www.cornerstonebusiness.com. David Dennis Repka, President of Bison Financial Group, Inc. helps his clients buy, sell and finance income producing properties. Since Bison was founded in 1994 they have participated in real estate transactions as a real estate or mortgage broker worth in excess of $500 million. For more information on Bison visit their website at http://www.bisonfinancial.com.