Tax Day = Savings

Have you ever wondered how some investors seem to pay less in taxes? If you have, you're not alone. The truth is, anyone can benefit from our tax system if they understand the basic rules of the game. Luckily, one tax "secret" that real estate investors use to minimize their tax liability on rental income is not hard to find - it's called cost segregation.

What is Cost Segregation?

Cost segregation is a tax strategy that allows real estate owners to accelerate the depreciation of their real estate by classifying certain parts of the building as personal property, meaning 100% of that asset can be depreciated in the first year. This strategy can increase cash flow and reduce federal and state income taxes on their rental income. Without a cost segregation study, real estate is typically categorized into two categories: land and building. Land is not depreciable, while the building is depreciated over 27.5 years (for residential properties) or 39 years (for commercial properties). While depreciation is beneficial, it does little to offset taxes without a cost seg.

Is Cost Segregation Worth It?

The value of cost segregation depends on your unique situation, which is why it's important to involve an expert. Thanks to the 2017 Tax Cuts and Jobs Act, used property is now eligible for 100% bonus depreciation, which can be taken on assets with tax lives of 20 years or less. This means that assets in the personal property and land improvements categories can be written off in the first year. However, it's important to note that the bonus depreciation rate will be phased out in the coming years, starting at 80% in 2023 and reducing to 0% in 2027 and later years. Nevertheless, even without bonus depreciation, there are still benefits to cost segregation due to the shorter depreciation periods of 5, 7, and 15 years for building components, compared to the standard 27.5 or 39 years for buildings.

Example of Cost Segregation

Let's look at an example to illustrate the potential benefits of cost segregation. Suppose you purchase a commercial warehouse for $5,000,000, ignoring the land portion. Without a cost segregation study, this property would be depreciated over 39 years, resulting in roughly $128,000 in depreciation expense per year. However, if a cost segregation study is performed, $1,000,000 can be considered as personal property, and $500,000 can be considered as land improvements, based on the current law concerning bonus depreciation. This means that $1,500,000 can be written off in the first year. The remaining $3,500,000 is depreciated over 39 years.

Assuming a 40% tax rate, this strategy would yield a federal income tax savings of $600,000 (1,500,000 x 0.40). Even if the full $1.5M cannot be utilized in the first year, the unused benefit/loss can be carried forward to offset future rental profits. The cash savings from the tax deduction can provide the property owner with the ability to invest in another sizable project by using the savings as a down payment.

Long-Term Benefits of Cost Segregation

The benefits of cost segregation extend beyond just the immediate tax savings. By accelerating depreciation deductions and reducing tax liability, property owners can significantly increase their cash flow, which can be used for other investments or business expansion. The additional cash on hand can also be used to fund renovations, upgrades, or other improvements to the property, thereby enhancing its value and potentially increasing rental income.

Furthermore, the ability to defer taxes through cost segregation can provide property owners with more flexibility in managing their overall tax burden. By reducing current tax liability, property owners can potentially invest in other income-producing assets or take advantage of other tax planning strategies.

Cost segregation studies also offer the advantage of providing a detailed breakdown of the property's components and their respective tax lives. This information can be beneficial for property owners in the future, as it can help them accurately track depreciation expenses and make informed decisions about property management, refinancing, or selling. Additionally, if the property is sold, the cost basis for each component can be used to determine the capital gains tax, potentially resulting in further tax savings.

In conclusion, a cost segregation study requires technical expertise and compliance with IRS regulations, so it's crucial to engage professionals with experience in this area. With the proper implementation of cost segregation, you can optimize your tax savings, increase your cash flow, and ultimately enhance your overall financial position in the real estate market

CVS Shifts Focus to Medtail

CVS, the well-known retail pharmacy chain, is shifting its focus away from retail and more towards the emerging trend of "Medtail." This shift is not surprising given that CVS has always been at the forefront of providing healthcare services. However, it is interesting to see how the retail giant is adapting to changing consumer needs and expanding its services beyond traditional pharmacy services.

So what is Medtail, and why is it becoming such an important trend? Medtail is a term used to describe healthcare services located in a retail setting. This includes everything from vision or dental offices to specialty wellness services, such as cosmetic and medical spas, occupational and physical therapy, skincare, etc.

The rise of Medtail is a direct response to consumers' increasing demand for more convenient and accessible health and wellness services. With the aging Baby Boomer population and increased focus on health, medical services have moved into retail spaces once occupied by apparel and accessory tenants. This new retail sector has become a great addition to the retail tenant mix, providing creative ways for landlords to fill vacancies and generate foot traffic.

CVS has recognized the potential of the Medtail trend and has been quick to respond to the changing needs of its customers. In 2019, the company launched HealthHUBs, which are dedicated spaces in their stores offering a wide range of healthcare services, including counseling, wellness programs, and even lab tests.

The company's move towards Medtail has been motivated by the need to provide customers with greater access to healthcare services in a convenient and accessible manner. CVS is expanding to provide a more comprehensive suite of healthcare services that go beyond traditional pharmacy services. By doing so, the company is catering to the evolving needs of the modern consumer, who is looking for more personalized healthcare solutions.

However, landlords need to be aware that Medtail tenants have different needs than typical retail tenants. Medtail tenants require specialized spaces that are equipped with the necessary equipment and infrastructure to provide healthcare services. Landlords will need to invest in the necessary infrastructure to accommodate these tenants, which could be a significant expense. Additionally, Medtail tenants may require longer leases and more extensive buildouts, which could make them less attractive to some landlords.

While building Medtail facilities will be costly, the business model is still more efficient than anything we have today. It's no secret that housing all medical services under one roof in a hospital can be a logistical nightmare. Not only do the processes for routine checkups differ from those required for more complex procedures, but the supply chains, operations, and buildouts for these services are also vastly different. Medtail, on the other hand, allows for healthcare services to be conveniently located in a retail setting, with each service occupying its own dedicated space. This model makes sense because it allows for a more streamlined and efficient delivery of healthcare services, with patients able to access the specific services they need without being subjected to the inconvenience and confusion of a hospital environment. Additionally, it allows for more specialized and personalized care, as healthcare providers can focus on their specific area of expertise without being bogged down by other services that are not relevant to their specialty.

The rise of Medtail is an exciting trend that is changing the face of the retail industry. The shift towards Medtail is a natural response to changing consumer needs and demands, and companies like CVS are leading the way in providing innovative healthcare solutions. While there are challenges associated with accommodating Medtail tenants, the potential benefits of increased foot traffic and revenue generation make it an attractive proposition for landlords. As the trend continues to grow, it will be interesting to see how the retail industry adapts and evolves to meet the changing needs of the modern consumer.

Self Storage Thriving

As a real estate investment trust, Life Storage operates more than 1,100 self-storage facilities in 37 states across the United States. Recently, the company made the news when it rejected an all-stock acquisition proposal from competitor Public Storage. Life Storage's board of directors unanimously rejected the offer, stating that it "significantly undervalues the company and its prospects for future growth and value creation." The company's ability to reject such an offer underscores how strong the self-storage business is today.

Despite the economic uncertainties brought on by the COVID-19 pandemic, the self-storage sector has been performing well. Although rental rates have slightly decreased, the demand for storage space remains high. One reason for this is that many people are moving to different cities and need a place to store their belongings temporarily. Additionally, people are downsizing their homes and may not have enough storage space for their possessions. Self-storage provides a practical solution for both groups.

The rejected buyout offer is particularly noteworthy because it came from Public Storage, one of the biggest names in the industry. Although the all-stock transaction valued Life Storage at around $11 billion, the company's board of directors rejected the proposal, citing the potential for greater risk-adjusted total shareholder returns as a standalone company.

In its decision, Life Storage highlighted its growth in net operating income compared to other self-storage REITs, including Public Storage. It also touted its ability to scale its portfolio "faster and more efficiently" than Public Storage. "Utilizing a strong and low-leveraged balance sheet, Life Storage has increased its total store count by nearly 50% since the beginning of 2019, outpacing Public Storage's approximate 19% store growth over that time," the release stated.

It's worth noting that despite the large size of some self-storage companies like Life Storage and Public Storage, 80% of the self-storage industry is actually owned by non-REIT "mom and pop" operators. This presents a huge opportunity for independent investors and entrepreneurs to enter the market and compete with the larger players. With the self-storage industry continuing to thrive, there is ample room for new players to enter the market and establish a profitable business. As long as people continue to move and downsize, the demand for self-storage will remain high, making it a lucrative industry for years to come.

Insights on Recent Sales Surge and Challenges Ahead

As the retail industry continues to adapt to changing consumer behaviors and economic trends, it's crucial to stay informed about recent developments and challenges. The recent surge in retail sales in the U.S. is a positive sign for the industry, with all retail categories showing gains from the prior month. In particular, department stores experienced a 17.5% rise, which is the largest increase in almost two years. Other big sales gainers for the month included car dealerships, furniture, and restaurants.

However, retailers are facing challenges such as inflationary headwinds and high interest rates, which can affect their profitability. Some retailers have had to offer price cuts to move inventory, resulting in weaker earnings. As a result, it is important to carefully evaluate the financial performance of a retail property before investing.

It is worth noting that while the recent surge in retail sales is encouraging, the overall economic environment remains uncertain. Consumer inflation is still near a 40-year high, and interest rates are expected to rise in the near future. Despite economic challenges, the U.S. job market continues to thrive, having generated over 500,000 new jobs in January.

By staying up-to-date with the latest economic and industry trends, we help our clients to make informed investment decisions and maximize returns. The U.S. retail landscape is evolving, and it is essential to stay ahead of the trends to succeed in this industry.