LOS ANGELES—Private and high-net-worth investors could be significantly maximizing their bottom line by utilizing a tool that larger, institutional owners use regularly. It is call accelerated depreciation or cost segregation, and it allows owners to take split up the depreciation of portions of the property, thereby increasing income after taxes. To find out more, we sat down with Gregg Bernstein, CFO and co-founder of LBPM, a property management company. Here, Bernstein answers all of our questions about accelerated depreciation and how all types of property owners can take advantage.
GlobeSt.com: What is accelerated depreciation?
Gregg Bernstein: Most people use straight line depreciation, but cost segregation is a way to take the standard straight line depreciation and identify specific pieces on the property that have a shorter useful life. If you divide that by 27 years, you can have a five, seven and 15-year property. That really dramatically increases your depreciation early on in the investment, which significantly increases your bottom line after tax. That is the really benefit of why people do this. It is a fairly common practice for more sophisticated apartment owners, but shockingly, it is not used as often as it should be by investors that have single-family homes or small portfolios of apartment buildings. They either don't know about it, or their accountants are hesitant to do it because it is not in their wheelhouse. This is a tool that is getting easier for less sophisticated investors to take advantage of.
GlobeSt.com: Why haven't smaller investors used this tool in the past?
Bernstein: Doing cost segregation theoretically increases your audit risk. So, we have started hiring engineering firms, and there are specialized firms across the country that do this, that will do inspections of all the structures of the property and break them down into their useful life property. That gives you a very detailed back up to support your depreciation. Those can be somewhat expensive, but usually it isn't so expensive that you wouldn't get the tax depreciation benefits. That is the first thing you can try. Second, some CPAs might try to break down the property on broad strokes: land, building, etc. Some CPAs feel comfortable doing that on their own. There are also some online tools the property owners can use to do it themselves. We don't have a lot of experience with how that goes through the IRS and if that is ever an issue. It does allow smaller and less sophisticated investors to take advantage of cost segregation.
GlobeSt.com: There seem to be a lot of benefits. What are the negatives?
Bernstein: The cons, beside the cost, depending on individual tax situations, there can be people that have exceeded their losses. That is a potential limitation. Theoretically, if you are depreciating quickly and you are seven or eight years into owning this building and you are running out of depreciation and you want to sell the building, you have potential recapture if you don't 1031 exchange the property. Those are really the negatives.
GlobeSt.com: What types of properties and investors can utilize this tool?
Bernstein: Any property is really a viable option. The real estate market is very competitive, and the multifamily market is at an all-time high. When you are looking at these investments and you are looking at fairly marginal returns, this is something for you to factor in because the income after taxes might push the deal forward. It is another tool to increase after tax bottom line to consider a deal that was maybe marginal before, particularly in a very competitive environment.
GlobeSt.com: How would a small investor start this process, if they were interested?
Bernstein: We assist our clients through this process, but we do not do these studies ourselves. Typically, because everyone's tax situation is so unique, we will discuss the process with their CPA. We are not tax experts, obviously, but we do try to help them on a macro scale to maximize the return of their property. This is just one extra tool. We can help connect the owner to other people in the process, like engineers and CPAs.
LOS ANGELES—Private and high-net-worth investors could be significantly maximizing their bottom line by utilizing a tool that larger, institutional owners use regularly. It is call accelerated depreciation or cost segregation, and it allows owners to take split up the depreciation of portions of the property, thereby increasing income after taxes. To find out more, we sat down with Gregg Bernstein, CFO and co-founder of LBPM, a property management company. Here, Bernstein answers all of our questions about accelerated depreciation and how all types of property owners can take advantage.
GlobeSt.com: What is accelerated depreciation?
Gregg Bernstein: Most people use straight line depreciation, but cost segregation is a way to take the standard straight line depreciation and identify specific pieces on the property that have a shorter useful life. If you divide that by 27 years, you can have a five, seven and 15-year property. That really dramatically increases your depreciation early on in the investment, which significantly increases your bottom line after tax. That is the really benefit of why people do this. It is a fairly common practice for more sophisticated apartment owners, but shockingly, it is not used as often as it should be by investors that have single-family homes or small portfolios of apartment buildings. They either don't know about it, or their accountants are hesitant to do it because it is not in their wheelhouse. This is a tool that is getting easier for less sophisticated investors to take advantage of.
GlobeSt.com: Why haven't smaller investors used this tool in the past?
Bernstein: Doing cost segregation theoretically increases your audit risk. So, we have started hiring engineering firms, and there are specialized firms across the country that do this, that will do inspections of all the structures of the property and break them down into their useful life property. That gives you a very detailed back up to support your depreciation. Those can be somewhat expensive, but usually it isn't so expensive that you wouldn't get the tax depreciation benefits. That is the first thing you can try. Second, some CPAs might try to break down the property on broad strokes: land, building, etc. Some CPAs feel comfortable doing that on their own. There are also some online tools the property owners can use to do it themselves. We don't have a lot of experience with how that goes through the IRS and if that is ever an issue. It does allow smaller and less sophisticated investors to take advantage of cost segregation.
GlobeSt.com: There seem to be a lot of benefits. What are the negatives?
Bernstein: The cons, beside the cost, depending on individual tax situations, there can be people that have exceeded their losses. That is a potential limitation. Theoretically, if you are depreciating quickly and you are seven or eight years into owning this building and you are running out of depreciation and you want to sell the building, you have potential recapture if you don't 1031 exchange the property. Those are really the negatives.
GlobeSt.com: What types of properties and investors can utilize this tool?
Bernstein: Any property is really a viable option. The real estate market is very competitive, and the multifamily market is at an all-time high. When you are looking at these investments and you are looking at fairly marginal returns, this is something for you to factor in because the income after taxes might push the deal forward. It is another tool to increase after tax bottom line to consider a deal that was maybe marginal before, particularly in a very competitive environment.
GlobeSt.com: How would a small investor start this process, if they were interested?
Bernstein: We assist our clients through this process, but we do not do these studies ourselves. Typically, because everyone's tax situation is so unique, we will discuss the process with their CPA. We are not tax experts, obviously, but we do try to help them on a macro scale to maximize the return of their property. This is just one extra tool. We can help connect the owner to other people in the process, like engineers and CPAs.
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