Cost segregation is a bargain tax strategy for shopping center owners
By Eli Loebenberg, ELoebenberg@madisonspecs.com
Depreciation is a commonly misunderstood area of accounting for property owners. In particular, many shopping center owners fail to approach it in the most advantageous way. They depreciate the total value of the buildings, land improvements and personal property over 39 years. Unfortunately, this isn’t necessarily correct. In many cases, as much as 40% of these assets are really land improvements and personal property that qualify for accelerated depreciation. Indeed, it is estimated that approximately 95% of all commercial real estate -- including shopping centers and malls -- is incorrectly depreciated over 39 years.
Increasing cash flow
According to the IRS, certain categories of fixed building assets can be depreciated more quickly, over five, seven or 15 years. Identifying and reclassifying these eligible assets can accelerate part of the building’s tax depreciation and create a reduced tax liability. A cost segregation study typically identifies 10% to 50% of assets that qualify and can be depreciated over a five, seven, or 15-year life. The result is an increase in depreciation expense, which reduces taxable income, which, in turn, increases cash flow. Given the current economy, a business strategy that helps property owners reduce current income taxes and increase cash flow has inherent value. Perhaps that is why more and more shopping center owners are turning to cost segregation as a strategy.
Eligible assets are systems, fixtures or related elements that are either unnecessary for the operation of the building itself or are temporary structures. They include such elements as decorative lighting or moldings, floor or wall coverings or redundant HVAC systems. An area of particular importance for shopping center owners is land improvements, which can often be very significant, and qualify for accelerated depreciation. Following the guidelines set forth by the IRS Audit Techniques Guide, tax and engineering experts separate out, or segregate, these assets. This process provides maximum tax benefits to property owners with facilities built or bought in the last seven years, as well as those with significant construction in progress, or with newly renovated or expanded facilities.
A real bargain!
Cost segregation saves shopping center owners money by justifying larger upfront tax deductions and in turn, lowering their tax payments. For example, an owner of a shopping mall was considering whether to do a cost segregation study. The mall’s anchor store was a Bass Pro Shop. The previous landlord had granted Bass an allowance of approximately $10 million to decorate and build out its space. The current owner was able to benefit from the improvements.
Despite the unusual nature of the eligible assets for depreciation, the decorative items in the Bass Pro Shop were eligible for five-year depreciation -- a significant tax benefit. Decorative elements included such unique items as taxidermy-stuffed animal hides, such as bears, deer, elk, foxes, Canadian geese, turkeys, and ducks. There were also indoor and outdoor waterfalls, as well as a custom-made 22,000 gallon fish tank! For the cost segregation study, the true price of the indoor and outdoor waterfalls, fish tank and stuffed animals were determined by having meetings and discussions with specific vendors. The study for the shopping mall generated a net present value tax benefit of nearly $1 million for the shopping center owner.
For new construction, it is best to incorporate cost segregation as early as possible in order to properly account for it on its initial tax return. For existing properties, the understated depreciation can be “caught up,” as is allowed by the IRS for past construction, purchases, expansions, renovations and qualified leasehold improvements. Missed depreciation is recaptured by filing a simple change in accounting method (IRS Form 3115), without requiring an amended tax return.
Without a doubt, a cost segregation study is among the most valuable tax strategies available to shopping center owners. To learn more about cost segregation, download Madison SPECS’ free publication entitled “All About Cost Segregation,” at madisonspecs.com.
Eli Loebenberg is CEO of Madison SPECS LLC, a division of Madison Commercial Real Estate Services, an umbrella organization offering specialty services nationwide for the commercial real estate market through a group of related companies. Loebenberg has over 12 years of broad-based tax experience, and is nationally recognized as an expert in cost segregation studies. A member of the American Institute of Certified Public Accountants, he can be reached at ELoebenberg@madisonspecs.com.