By Lauren Bens
Historically, commercial real estate has been proven to be a stable and tangible return on investment, and less volatile compared to the stock market. CRE also boasts the ability to leverage the borrower’s capital and the ability for the investor to quickly scale their portfolio. Several real estate tax advantages offer enticing returns such as capital gains deferrals, tax-deferred retirement accounts and tax write-offs referred to as deductions. To defer taxes and “swap” a property, one can perform a 1031 exchange. One can also accelerate their depreciation through a process the IRS calls Cost Segregation.
A 1031 exchange allows an investor to defer capital gain taxes when they sell investment real property by exchanging it for other like-kind investment real property. If done in compliance with Internal Revenue Code and the accompanying Treasury Regulations, the capital gains are essentially transferred into a new purchased real property. If the individual follows section 1031 of the Internal Revenue Code, they will pay little to no taxes at the time of the exchange. There is no limit to the number of times one can defer the taxes, so long as the newly sought asset in the exchange is of equal or greater value, and all the proceeds from the sale are spent to acquire the new real property. Taxes will only need to be paid once the final asset is sold and the person pockets their profits.
Additional benefits of performing a 1031 exchange include the ability to scale and diversify one’s portfolio. Leveraging equity from the initial asset, consolidating properties, and prioritizing and optimizing investments are beneficial. Qualified intermediaries should be contacted prior to the purchase of the new property to successfully coordinate the deferment process. Michael Brady is an Executive VP at Madison Exchange, a leading national Qualified Intermediary for 1031 exchanges. Michael educates investors, tax and legal advisors about 1031 exchanges. He stresses the importance of contacting a qualified intermediary as early as possible, given the rigid deadlines and complexities that may arise.
Depreciation accounts for a decrease in value over the expected life, 27.5 years for residential structures and 39 years for commercial properties. To hasten the “write-offs” the IRS allows for deductions of personal property within the building, such as furniture, flooring, and fixtures, at 5 years and “land improvements” outside the building, such as signing, fencing, and landscaping, at 15 years.
This enables investors to depreciate property at an accelerated rate and save an enormous amount of taxes soon after purchasing the property. Generally, 15-35% of the property value can be pre-classified through cost segregation. And one can lower their tax liability to zero.
This requires a team of competent engineers trained in tax codes and tax experts well-versed in the IRS techniques and methods, who carefully work together to conduct a cost segregation study. This is a carefully documented study that most CPA’s are not qualified to conduct. Yonah Weiss, known as the “Cost Seg King”, a business director at Madison Specs, recommends Cost segregation for people who own an investment or business property, generally priced at $500,000, purchased within the last 5 years and who plan to hold their property for minimum one year.
Yonah offers recommendations for choosing a cost segregation firm. The must have extensive experience, in-house teamwork, maintain E & O insurance, provide audit defense, and have their engineers conduct onsite inspection. It is beneficial that the team collaborate with the investor’s accountant.