Quarterly: Summer 2004 - GWCAR - Greater Washington Commercial Association of REALTORS

CBQ >> Summer 2004 Issue

Understanding Cost Segregation

By Thomas Goubeaux
Probity Integrated Asset Services

Although CFO's and many CPA's are familiar with Cost Segregation, or Cost-Seg for short, it has been beyond the focus of the brokerage and asset management community… that is until recently. Real estate is a service industry where distinction from one's peers matters. Proactively serving your client's needs better than the next guy earns loyalty, opportunity and income. Thereby, some familiarity with a process that benefits your client is a good thing to possess. This brief provides a light hearted understanding of the concept and benefits of Cost-Seg.

Just what is Cost Seg? What value is it to my clients and what's in it for me?
Cost Segregation is an IRS sanctioned means of accelerating the depreciation of real property. The Cost-Seg process allocates, or more appropriately re-allocates the cost of real property components from long term into short term depreciation. The overall depreciation schedule is thereby transformed from an evenly-distributed model into a composite version that is front end loaded.

Sounds like "accountant-eeze" to me-get to the point.
Since depreciation is a bona fide tax deduction, the increase in the early years translates into realizing the tax savings sooner. Depending upon the property, the tax deduction in the first five years may increase twofold-now that's real money. It's akin to a broker getting paid most of his commission up front. The overall amount of the money hasn't changed, but there is a clear advantage to receiving the money now rather than later. Have you ever won the lottery? Did you take the money up front, or opt for the long term annuity? Get the idea?

When should I speak with my clients about this?
The advantage to your client varies dependent upon the entry point into the acquisition or construction process. Earlier is better-a consult during lease negotiations is a very, very good idea. Later works too-up to three years after the sale of a property or move-out date of a leased space. Regardless of whether the client is the landlord or the tenant, the salient point is the client has had to pay for some portion of the property to be eligible. Actually, both parties to a lease may benefit when each contributes to a portion of the cost.

I have some savvy clients. After all, that's why they retain me. Wouldn't they already be on board with Cost-Seg?
Perhaps, but just as brokerage services are not equal, neither are Cost-Seg services. A recent article in Commercial Property News noted a reallocation of 3 to 8 percent of the property as a norm for the industry; the best services are achieving 12 to 14 percent on average, with some properties realizing more than 22 percent. Your savvy client may be quite content with his 3 to 8 percent, but he will be thrilled when you advise him that he can increase that benefit substantially via a new comprehensive analysis performed by a firm with more effective expertise. What's more, he may do cartwheels when you tell him that the gains in benefit may be retroactive.

Okay, but what's in it for me?
As a real estate broker, you strive to distinguish yourself from your peers. Your clients rely upon your counsel regarding matters beyond the transaction at hand. You recommend architects, contractors and the like to solidify your position as your client's go-to resource. Cost-Seg provides an opportunity to introduce a concept and an entity that not only makes you look good, but makes real money for your client. Besides, a few Cost-Seg firms award referral fees-mine does.

Thomas Goubeaux is a principal at Probity Integrated Asset Services, a DC based firm specializing in comprehensive Cost-Seg analyses. You may contact him at tgoubeaux@probityias.com.