Mixed Use Property and Cost Segregation

[Julio Gonzalez]

Have you ever wondered if you’re paying too much in taxes? For buildings that are mixed-use meaning to have areas that qualify as both commercial and residential spaces, the tax law can be even more complex and confusing than a single-use property. As such, many taxpayers are overpaying because they aren’t aware of the tax benefits available to mixed-use property owners.

One of the most beneficial tax strategies for mixed-use property is a cost segregation study. We’ll discuss this concept further, but let’s first start with understanding what a mixed-use property is.

Mixed-use property has become a very popular concept in cities. It’s an easy way to add commercial space at the bottom of the building with residential space at the top of the building. It makes sense - imagine living right above your favorite coffee shop or grocery store! While they are attractive logically speaking, they can be a bit of a challenge for taxes. This is because the tax code is not designed to have the two property types be intertwined. This can lead to missed deductions or credits and overpayment of taxes.

A Cost Segregation study is an IRS approved federal income tax tool that increases near term cash flow by utilizing shorter recovery periods for depreciation to accelerate return on investment. For newly constructed, purchased or renovated properties and also retroactive generally over the last 10 years, building components are properly classified into individual units of property and accurate recovery periods for computing depreciation deductions. The study identifies with forensic engineering detail the immediate Bonus Depreciation 5, 7 and 15-year personal property class lives qualifying portions of a building that are normally buried in 27.5 year residential or 39 year commercial categories. Here’s an article addressing Cost Segregation Study FAQs.

Asset classification becomes very confusing with mixed-use property as mentioned above, the useful life for commercial properties is 39 years and for residential properties, it is 27.5 years. This is where the 80% rule will come into play. If 80% or more of the income is from the commercial space, the property is classified as non-residential and depreciated over 39 years. If 80% or more of the income is from the residential space, the property will be classified as residential and is depreciated over 27.5 years. For further complex tax codes that are important to understand, review Section 1250 and 1245.

Cost segregation offers many unique benefits including optimizing cash flow, deferring taxes and improving asset management. You’re able to defer taxes by accelerating the depreciation of specific assets which helps reduce your taxable income, thus deferring your tax liability into future years. By reducing your tax liability, this increases your cash flow and extra liquidity you have to reinvest in your real estate portfolio to help create exponential growth. Having the knowledge of the exact value of each asset helps you make better property management decisions such as making decisions on asset disposition, repair or renovations.

The great news is that you don’t have to go at it alone on understanding your mixed-use property’s taxes. First, ensure you have a CPA that specializes in real estate. Next, reach out to cost segregation firms in order to obtain a free cost/benefit analysis quote. Here are some questions to ask when interviewing a cost segregation firm. Lastly, here’s what to expect when obtaining a cost segregation study.

What other questions do you have regarding mixed-use property or cost segregation studies?