Utilizing cost segregation studies is a common technique to increase cash flow, offset income and minimize taxes. Generally speaking, an asset such as a hotel, multifamily property or commercial building can garner a 20-30% increase in bonus depreciation that is 100% deductible against taxable income as a result of undergoing a study. This is useful when, for example, you purchase a $5,000,000 real estate asset and a cost segregation analysis generates $1,000,000 of additional bonus depreciation in year 1.
In some unique situations, this may not be enough to offset This is where a unique asset class comes into play. Gas stations and convenience store (c-store) real properties that qualify as a ‘retail motor fuel outlet’ are eligible to elect a depreciable life of 15 years rather than the traditional 39-year depreciable life of ordinary real estate. The Tax Cuts and Jobs Act (TCJA) allows for 100% bonus depreciation of qualified property – that is, property eligible for the modified accelerated cost recovery system (MACRS) with a recovery period of 20 years or less. This means that in the year of acquisition of a gas station or c-store asset you can immediately write off up to 80-90% of the asset’s value – the remaining 10-20% being the non-depreciable land.
Say for instance you have a $25 million passive gain you’re looking to offset. Leveraging your cash into a gas station portfolio with NNN leases where the tenant is responsible for all maintenance, taxes and insurance will generate a significant tax deduction over any other asset class. Based on the credit quality of the tenant, an investor can expect to find assets in the 4 to 6% cap rate range for high-quality credit grade tenants and multi-unit non-credit deals in the 7 to 8% cap rate range. Many of these deals are regional or national operators who guarantee the lease and a minimum of 15 years and unlike many other NNN properties, they frequently have annual rent increases. Also, note that active gains may be generated through this asset class by actively managing or participating in the business.
An investor should ensure that they’re buying the right real estate – and not just the tax play- so that if a tenant defaults or there is a significant shift towards green energy in the long term, the value and location allow for a pivot. In our current interest rate environment, these assets can be leveraged at 65 to 70% Loan-To-Value at rates in the 3.25% to 3.75% range for non-recourse debt. Gas stations are considered an essential business and therefore face somewhat less risk than other retail in the current environment – and given current interest rate levels and the bond market environment, owning real estate is a tremendous hedge against inflation.
The flip side to this passive bond-like asset is that the potential upside and cash out opportunities from something like value-add multifamily do not exist. As with any asset where you utilize accelerated depreciation, there are tax considerations on exit. Accelerating the depreciation of post-1986 real property subjects it to recapture tax (Section 1250 rules). Recapture tax can be deferred through a like-kind exchange of similar or related property to the extent it is like-kind (real property).
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