In today's competitive commercial real estate market, you need to use every tool available to make a deal happen. One tool that is underutilized that could make a difference in creating a viable deal from one that is border line is a Cost Segregation Study.

How can a Cost Segregation Study help? (I'll explain what a Cost Segregation Study is later.) The future owner benefits from the study by creating tax benefits that result in almost immediate increased cash flow. All this can occur very soon after the purchase of the property. So this can be taken into account when working the numbers in a deal. The increased cash flow can push the deal over the top. It will also put the owner in a position for additional transactions sooner than anticipated.

Cost Segregation is a strategic tax benefits tool that allows property owners who have constructed, purchased, expanded, or remodeled any kind of real estate to increase cash flow by accelerating depreciation deductions and deferring federal and state income taxes.

Cost Segregation is the identification, separation and reclassification of building components to shorter, accelerated depreciation lives that are less than the traditional 39-year life required for the building itself.

In general, it is easy to identify furniture, fixtures, and equipment that are depreciated over 5 or 7 years for tax purposes. However, a Cost Segregation Study goes far beyond that by dissecting construction costs that are usually depreciated over 27 or 39 years.

The primary goal of a Cost Segregation Study is to identify all construction-related costs that can be depreciated over 5, 7 or 15 years. For example, 30% to 90% of the total electrical costs in most buildings can qualify as personal property (depreciated over 5 or 7 years). Reducing tax lives results in accelerated depreciation deductions, a reduced tax liability, and increased cash flow.

Here's a table showing the typical eligible percentages of a property's value (not including land) that can be reclassified to shorter depreciation lives:

Property Type: Typical Eligible Percentages
Assisted Living: 15 - 25%
Apartment Building: 20 - 35%
Automobile Dealership: 25 - 50%
Bank/Financial Institution: 15 - 30%
Computer Technology Center: 20 - 60%
Distribution: 5 - 15%
Fitness/Health Club: 20 - 30%
Golf/Resort: 20 - 40%
Heavy Manufacturing/Processing: 30 - 60%
Hospital/Medical Office Building: 20 - 50%
Hotel and Motel: 20 - 30%
Light Manufacturing: 20 - 40%
Office Building: 20 - 40%
Research and Development: 20 - 60%
Restaurants (single or multiple): 20 - 40%
Retail (dept/specialty store): 20 - 30%
Self Storage Facility: 20 - 80%
Strip or Regional Mall: 10 - 30%
Supermarket: 20 - 30%
Tenant Improvements: 10 - 50%
Theater: 20 - 30%
Warehouse: 5 - 10%

Here's a table of some actual examples:

Property: Acquired Outpatient Surgery Center
Tax Basis: $1,843,000
Percent Reclassified: 45%
Present Value of Tax Benefits: $154,000

Property: Acquired Office/Warehouse
Tax Basis: $6,050,000
Percent Reclassified: 15.9%
Present Value of Tax Benefits: $148,000

Property: New Bank Building
Tax Basis: $3,600,000
Percent Reclassified: 31.7%
Present Value of Tax Benefits: $180,000

Property: New Assisted Living Center
Tax Basis: $2,860,000
Percent Reclassified: 32.1%
Present Value of Tax Benefits: $156,000

Property: Acquired Retail Shopping Center
Tax Basis: $7,140,000
Percent Reclassified: 18.4%
Present Value of Tax Benefits: $215,000

As you can see, a Cost Segregation Study can help increase cash flow and may be enough to make a deal viable. The actual study would not be performed until after the acquisition of the property but a fairly good estimate can be made beforehand by an experienced firm based on industry knowledge and their own database of performed studies.

Even if a transaction is financially sound, it would be wise to recommend a Cost Segregation Study to the new owners because of the potential tax benefits and resulting cash flow. It could only enhance your position in their eyes and could lead to more business from them and referrals as well.

Don't overlook recommending a Cost Segregation Study to your existing clients. By saving your clients potentially hundreds of thousands of dollars, you will keep them as clients a long time and make asking and receiving referrals much easier. It's a great strategy that will pay dividends over and over again.