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By AZ Advisory Team, February 1, 2010 12:36 pm

Continued…

Annual Debt Service (ADS)

The ADS is the total of loan payments for the year. The annual debt service includes the principal and interest portion of the payment for all twelve months.

Cash Flow Before Taxes (CFBT)

Cash Flow Before Taxes is the amount of money realized by the investor for the year, whether positive or negative, before income taxes are computed.

Taxes (T)

This is simply the taxes you pay in connection to your property.

Net Income (NI)

This is your Net Income for the year after paying taxes. This is the amount of money realized after the payment of taxes.

Investment Cost (IC)

Investment Cost is the total amount of money you released to purchase that property including the professional fees and other expenses associated with buying that commercial investment property.

Return on Investment

When your Net Income added yearly reaches to a point that it surpasses your Investment Cost, then you have reached a Return on Investment.

Alex Zylberglait provides commercial real estate investment advisory as well as research, estate planning, asset allocation, valuation, financing, special assets services, transaction advisory and commercial property acquisition and disposition services.

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By AZ Advisory Team, November 24, 2009 2:58 pm

Overlooked Opportunity

Accounting professionals must be able to suggest and help implement cost segregation for their clients or employers so they can achieve maximum tax savings. In the past when taxpayers purchased real estate, they traditionally allocated 20% of the purchase price to land and 80% to buildings. While the IRS rarely questioned this simplistic approach, purchasers did themselves a financial disservice: They forfeited opportunities to achieve a better tax result.

Although the cost segregation technique always was available to real estate purchasers, it often was overlooked as a tax-savings tool. Recently, however, buyers have begun to recognize that despite some drawbacks, cost segregation can dramatically increase tax savings. They are, therefore, taking advantage of this opportunity, challenging the “business as usual” mantra.

Alex Zylberglait provides commercial real estate investment advisory as well as research, estate planning, asset allocation, valuation, financing, special assets services, transaction advisory and commercial property acquisition and disposition services.

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By AZ Advisory Team, November 20, 2009 4:31 pm

Practical Tips To Remember

CPAs should routinely recommend that their clients or employers use cost segregation studies whenever the expenditures for a structure, including leasehold improvements, equal or exceed $750,000.

Cost segregation can be used for new construction and improvements, for the purchase of existing structures and for buildings acquired in prior tax years—even if the building has been disposed of.

A taxpayer that uses cost segregation for a previously acquired structure must file IRS Form 3115, Change in Accounting Method.

If a taxpayer disposes of a building for which cost segregation was used, it should consider the recapture considerations associated with this disposition.

Alex Zylberglait provides commercial real estate investment advisory as well as research, estate planning, asset allocation, valuation, financing, special assets services, transaction advisory and commercial property acquisition and disposition services.

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By AZ Advisory Team, November 18, 2009 11:27 pm

Decrease Expenses

Evaluate the historical operating statements of the property to determine if there are areas where you can decrease expenses. For example, perhaps improving the property with more energy efficient light bulbs in the common areas will drastically reduce your monthly electrical bills. Or perhaps you find that the gas company can individually meter the units so that instead of paying for the gas, you can fairly pass that expense onto the tenants. In the vast majority of instances, a commercial property owner can cut expenses without significantly impacting the operations of the real estate itself.

Alex Zylberglait provides commercial real estate investment advisory as well as research, estate planning, asset allocation, valuation, financing, special assets services, transaction advisory and commercial property acquisition and disposition services.

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By AZ Advisory Team, November 13, 2009 8:00 am

How the Technique Works

The process of cost segregation begins at the time of purchase. Accounting professionals should advise clients or employers buying real estate to use an engineering report to segregate assets into four categories. This article focuses on cost segregation for buildings.

The building. Buyers should attempt to maximize a building’s value; any residual value will be allocated to nondepreciable land. Although a building’s separate components (such as its roof) all are considered part of the building itself, there is merit to valuing and depreciating each component separately (albeit, on the same depreciation schedule). This way, if one of the building’s components subsequently becomes worthless, the taxpayer can write it off immediately.

Alex Zylberglait provides commercial real estate investment advisory as well as research, estate planning, asset allocation, valuation, financing, special assets services, transaction advisory and commercial property acquisition and disposition services.

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By AZ Advisory Team, November 6, 2009 3:51 pm

Present-Value Savings

Each $100,000 in assets reclassified from a 39-year recovery period to a five-year recovery period results in approximately $16,000 in net-present-value savings, assuming a 5% discount rate and a 35% marginal tax rate.

CPAs play a central role in the cost segregation process. They are the most likely people, in addition to a good broker, to recommend use of the technique to their clients or employers. CPAs also will review and implement the findings in the required engineering report. This article will guide CPAs through the process by discussing how cost segregation operates, providing a comprehensive example of the technique in a real estate acquisition and outlining its advantages and disadvantages.

Stay tuned for the continuation next week.  Thanks!

Alex Zylberglait provides commercial real estate investment advisory as well as research, estate planning, asset allocation, valuation, financing, special assets services, transaction advisory and commercial property acquisition and disposition services.

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By Alex Zylberglait, October 30, 2009 8:25 am

We have been talking about Cost Segregation for quite sometime now in my print and e-newsletters – the Real Estate Investment Digest, as well as in one of  my past conference calls.

For those of you who missed it, Cost Segregation is a strategic tax savings’ tool that allows companies and individuals who have constructed, purchased, expanded, or remodeled real estate to increase their cash flow by accelerating depreciation deductions and deferring their federal and state income taxes.

The goal of a Cost Segregation study is to identify, segregate, and reclassify project-related costs that are currently classified as real property to shorter depreciable tax lives for federal and state income tax purposes.  Recent IRS rulings and procedures have allowed taxpayers to change accounting methods to take advantage of these previously understated depreciation expenses–back to 1987.  This is done without amending tax returns.

Cost Segregation started in the 1960’s and has been called component depreciation studies, investment tax credit studies and various other names.  No matter what name you use–Cost Segregation can save you tax dollars and increase your cash flow.  There are over 300 court cases and I.R.S. rulings supporting the benefits of Cost Segregation.  The following is an example.

Hospital Corporation of America v Comm. 109 TC 21 (1997) ruled that certain assets associated with a specific piece of equipment not linked to the normal operation and maintenance of the building qualify for five-year depreciable tax lives instead of 39-year depreciable tax lives.

Essentially, the tax courts and IRS have agreed that the taxpayer can use a Cost Segregation study to segregate the cost of his assets.

Standby as I elaborate on what Cost Segregation can does.  At the end of this series, I would recommend companies specializing in this field.

Alex Zylberglait provides commercial real estate investment advisory as well as research, estate planning, asset allocation, valuation, financing, special assets services, transaction advisory and commercial property acquisition and disposition services.

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By Alex Zylberglait, September 17, 2009 8:00 am

Calculating Modified Internal Rate of Return

MIRR is an alternative to the traditional calculation of the IRR in that it computes an IRR with an explicit reinvestment rate assumption.

The discount rate that equates the present value of all negative cash flows (including the down payment) to the future or terminal value of all the positive cash flows is the MIRR.

While the internal rate of return (IRR) assumes the cash flows from a project are reinvested at the IRR, the modified IRR assumes that all cash flows are reinvested at the firm’s cost of capital. Therefore, MIRR more accurately reflects the profitability of a project.

For example, say a two-year project with an initial outlay of $195 and a cost of capital of 12%, will return $121 in the first year and $131 in the second year. To find the IRR of the project so that the net present value (NPV) = 0:

Thus, using the IRR could result in a positive NPV (good project), but it could turn out to be a bad project (NPV is negative) if the MIRR were used. As a result, using MIRR versus IRR better reflects the value of a project.

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Alex Zylberglait provides commercial real estate investment advisory as well as research, estate planning, asset allocation, valuation, financing, special assets services, transaction advisory and commercial property acquisition and disposition services.

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By Alex Zylberglait, September 15, 2009 9:31 am

Internal Rate of Return

IRR equates the present value of the positive cash flows and the present value of the negative cash flows. The decision rule for IRR is if the IRR is greater than or equal to an investor’s required rate of return, the investment should be accepted; otherwise it should be rejected.

The discount rate often used in capital budgeting that makes the net present value of all cash flows from a particular project equal to zero. Generally speaking, the higher a project’s internal rate of return, the more desirable it is to undertake the project. As such, IRR can be used to rank several prospective projects an investor is considering. Assuming all other factors are equal among the various projects, the project with the highest IRR would probably be considered the best and undertaken first.

IRR is sometimes referred to as “economic rate of return (ERR)”.
You can think of IRR as the rate of growth a project is expected to generate. While the actual rate of return that a given project ends up generating will often differ from its estimated IRR rate, a project with a substantially higher IRR value than other available options would still provide a much better chance of strong growth.

IRRs can also be compared against prevailing rates of return in the securities market. If a firm can’t find any projects with IRRs greater than the returns that can be generated in the financial markets, it may simply choose to invest its retained earnings into the market.

Up next this Thursday, I’ll show you how to calculate for the Modified Internal Rate of Return.

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Alex Zylberglait provides commercial real estate investment advisory as well as research, estate planning, asset allocation, valuation, financing, special assets services, transaction advisory and commercial property acquisition and disposition services.

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By Alex Zylberglait, September 10, 2009 10:30 pm

We have discussed Discounted Cash Flow, now let us go to Net Present Value.

NPV is the sum of the present values of a commercial real estate investment’s positive cash flows and the present values of its negative cash flows. This calculation results in a single sum that can be positive or negative. Investors generally specify a required or target rate of return for investing capital; it is an “opportunity cost” concept.

The general rule for considering an investment is if the NPV is greater than or equal to zero, the investment should be accepted; if the NPV is greater than or equal to zero, an investor must be earning at least the required rate of return. In fact, if the NPV is equal to zero, the rate of return being earned on the investment is exactly equal to the specified required rate of return. If the NPV is negative or less than zero, the investment should be rejected because the investor is not earning the required rate of return.

The difference between the present value of cash inflows and the present value of cash outflows. NPV is used in capital budgeting to analyze the profitability of an investment or project.

NPV analysis is sensitive to the reliability of future cash inflows that an investment or project will yield.

Formula:

Up next on Tuesday, we’ll talk about Internal Rate of Return.  Thanks.

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Alex Zylberglait provides commercial real estate investment advisory as well as research, estate planning, asset allocation, valuation, financing, special assets services, transaction advisory and commercial property acquisition and disposition services.