Investment Real Estate Management: A Tax Perspective

Proper investment real estate management for business owners can pay-off big. If you’re privy to the advantage of proper tax planning before making taxing decisions, it can often put some big tax savings in the pocket of the well-advised. To understand the advantage of proper tax strategies for investment real estate management, read further.

Say a business owner is planning a $4m investment in a new facility for their developing business; the first pertinent tax planning item is the importance of a cost segregation study. A cost segregation study is a process of identifying personal property assets that are components in real property (the building); then segregating the personal property from the real property for tax purposes. While “property” may appear homogenized in definition to many business owners, for tax purposes there is a significant difference in the lingo between “real” and “personal” property.  The purpose of the cost segregation study is to abbreviate the depreciation time for tax purposes and therefore, accelerate the expense, resulting in more tax savings. The primary goal of the cost segregation study is to identify construction and building items that can be depreciated at an accelerated rate, e.g. 5, 7 or 15 years, and applicable bonus depreciation vs. the 39 years for the non-residential real property.

The abbreviated depreciation period(s) obtain a greater immediate tax benefit  and expense for the investment real estate management portfolio, i.e. depreciation of say maybe 40% of building in 7 years vs. 39 years. Often, a construction engineer will prepare and review the cost segregation study for appropriateness of depreciation methodologies on the building components. The cost segregation study includes a nonintrusive yet detailed knowledge of the building’s walls, flooring, ceilings, HVAC, plumbing, electrical wiring, lighting and other soft costs, including engineering fees, and say architecture. Cost segregation studies are often outsourced to specialist firms with in-depth engineering knowledge of building components and infrastructure. At the completion of the cost segregation study, your accountant will receive detail of the building “assets”. Instead of two line items on a depreciation schedule, say $3.2m for the building and $800,000 for land, (that is like taking the IRS to a yearly smorgasbord – forfeited tax savings,) with a cost segregation study you will have the detail of each the specific building components in a segregated detail for the buildings tax depreciation schedules.

The next step in an appropriate investment real estate management is the planning recapture taxes before the sale of the portfolio. While the cost segregation study abbreviates the depreciation period and accelerates the expense, one item often considered problematic in the investment is that if you sell the property, there is recapture tax on the depreciation at ordinary rates.

An informed tax accountant will help you plan retirement, with the retirement of the components of the building from the cost segregation study. Let’s say your lighting fixtures cost basis on the cost segregation study is $250,000. Once the lighting fixtures are completely depreciated, your tax accountant should retire those assets for investment real estate management purposes. The retirement of the assets minimizes the recapture tax on a future sale of the building. The difference on the planned asset retirement is to say a capital gain tax of 20% on the lighting assets vs. ordinary recapture tax of 35%. This say 15% tax savings is $37,500 more gain on your investment real estate management, and in this example that is nearly a 1% gain on portfolio cost basis, simply from planning recapture tax savings.

If you renovate or remodel the building, you will also want to request that your tax accountant adjusts the asset depreciation schedules for appropriate asset dispositions at those appropriate times, i.e. when disposition or renovation takes place, expensing the remaining cost basis on asset dispositions and avoiding unnecessary recapture taxes in the future.

To sum it up, this blog is not to be construed as tax advice, only an awareness of the value of appropriate tax strategies for investment real estate management, and the savings and tax benefits it can bring to your business, and business partners.