Cost Segregation Covers Closing Costs for the Commercial Real Estate Investor!
There is a simple program that covers closing costs for qualified buyers of commercial or residential rental property. We use a tax strategy that generates 5% to 12% of the purchase price (or construction cost) of the building and land improvements. This strategy is called cost segregation, or cost seg. For those familiar with cost segregation, you might find this approach offers a new twist on an IRS proven method of accelerating depreciation through Modified Accelerated Cost Recovery System.
Cost segregation identifies all building components and classifies them using IRS guidelines for depreciable property. These assets can be depreciated over multiple year brackets of 5, 7, 15, 27½ and 39 years. Multifamily (residential) property is depreciated over 27½ years and all other over 39…these classes are considered “real” property.
Assets qualifying for the short periods of 5 & 7 years are considered “tangible personal property” and those of 15 years are considered land improvements. Cost segregation is the method used to identify these short-life assets and the IRS says that engineer-conducted studies are the benchmark for meeting IRS scrutiny…all other methods are suspect at best and are subject to IRS audit.
Now, cost segregation usually reclassifies about 18% – 35% of real property to tangible personal property…so the bottom line is that it can generate upwards to $150,000 in income tax credits/refunds to the owner per million invested. The key here, and it is definitely KEY, is the buyer must be paying income taxes, or has paid income taxes in the last 7 years, so the credit can result in a refund. If this is the case, then the buyer will have more than enough cash from the results of the cost seg study to cover all closing costs and ancillary fees (e.g., buyer’s agent commissions, etc.).
If not, the other scenario that will work, with a willing lender, is to use the tax credit as collateral and “borrow” against it for the closing costs. Additionally, with the extra cash flow from cost seg, the borrower can negotiate for better loan terms.
There are 3 reasons for this:
• cash flow is critical for debt service and the bank realizes this;
• real estate taxes are reduced commensurate to the reclassification of personal property; and,
• property insurance premiums are lower due to the same reclassification of personal property assets.
These all add up to lower operating expenses making any loan package more feasible due to the increased cash flow. Additional cash flow from cost segregation can either:
• Give bank a financially stronger borrower; or,
• Allow bank to require a replacement reserve of some amount; or
• Allow bank to require additional principal reductions to lower LTV to preferred level; or,
• Make a difference between meeting bank’s DSC requirement for the proposed loan or falling short of policy.
If a lender is unwilling to do so, an alternative is to partner with entities (individual investors, LLCs, REITs, etc.) needing tax credits to shelter income…of course they need to have the cash, or cash flow, to support the closing costs needed. Where there’s a will there’s a way.
This strategy can be used for any type property regardless of other mitigating factors.
Cost segregation delivers results every time it is applied.
For more information on how to apply cost segregation to your property purchase or new construction, contact us at…