I've been a CPA for nearly 20 years - serving private small business and real estate the entire time. I take the lessons learned in serving and now running a small business and share them here. For business owners, investors, and advisors looking to lower their cost of capital, subscribe for delivery straight to your inbox π Also on YouTube at PlugAccountingandTax!
How Long of a Hold Makes Sense for a Cost Segregation Study? β
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3 years. Now on to the memes. π Only kidding. Obviously there's a lot of nuance to this question I get several times a year (albeit less often with the real estate market being where it is now). Let's look at the factors that impact to Cost Seg or not to Cost Seg: Covering the Obvious - RecaptureThe primary argument against cost segregation studies is "depreciation recapture." π± Most of my readers are likely real estate literate and understand the concept, but just quickly for those unfamiliar. When you take bonus depreciation on short life assets (anything 15 years and less - land improvements, furniture, fixtures), you have an obligation to repay any gain attributable to those assets when sold back at ordinary rates. So if you bonus depreciate a $5,000 couch, and later that couch is sold for $6,000 - $5,000 of that gain is taxed at ordinary income tax rates and $1,000 is taxed at capital gains rates. This is referred to as 1245 property recapture (the tax code section that defines that property). But who sells a couch for more than they bought it? Exactly the point. π The ArbitrageWhen real estate gets sold, many (most) CPAs will allocate the sales proceeds "pro-rata" against the basis of the component assets. So if total property (land + building + short lived assets) = $1,000,000 basis and sales price was $1,500,000, then all assets receive a 50% gain. This guarantees maximum recapture π ββοΈ on any depreciation taken on those short lived assets. Not great, Bob. What we always do in the year of sale is work to analyze the real fair values of those components with our clients. Of that $500,000 in appreciation, how much was to the land and building? Those are the assets that don't have the same penalizing recapture rates. This is the arbitrage you're chasing as the property owner and seller - taking ordinary depreciation now, selling at a gain, and shifting the gain (realistically) from short lived assets to land and building. It can save anywhere from 12% to 17% of income taxes. (37% max ordinary rate; 25% recapture gain rate on building; 20% capital gain rate on land) π° So How Long Do I Need to Hold?So the same year probably isn't going to make sense - every gain will be short-term capital gains (ordinary rates). And will you clear your promote within 2 years? If so - great. But most operators I work with look at year 3 as the first real opportunity to clear hurdles and be in the money. So if it's a 3 year hold, does it still make sense to do a cost segregation study? The question you need to ask yourself is how much of the appreciation on the exit is related to the $5,000 couch ποΈ versus the land and building. π’ The further we get away from purchase date, the more it makes sense that the appreciation is from the land and to a lesser extent building. But that doesn't have to be 10 years - usually we can start to make that link at 3 years or longer. Need a Cost Segregation Study?If you're in the market for a cost seg study, I send all my clients to RE Cost Seg. I'm not an investor or owner, but do have a referral link if you'd like to help support this newsletter - https://get.recostseg.com/zvmjnm76al0zβ π«‘ Group Chat Worthy Posts π₯π²
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The Plug [Newsletter]
I've been a CPA for nearly 20 years - serving private small business and real estate the entire time. I take the lessons learned in serving and now running a small business and share them here. For business owners, investors, and advisors looking to lower their cost of capital, subscribe for delivery straight to your inbox π Also on YouTube at PlugAccountingandTax!
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