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Going Green Just Got A Little Greener
by Jerry Kootman, CPA

It's Time to Invest in Our Environment and Your Future Growth

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Many commercial property owners have already taken the leap to construct green or sustainable buildings not only as a responsible corporate decision but as a competitive edge.  A clear trend towards providing green spaces for tenants is evident and will continue to affect the marketability of available spaces.  The economics associated with a green project, particularly in the early years, is still a concern for developers although long term efficiencies should justify the overall increase in the development costs and project risk.  Couple this extra drain on cash with our current economic conditions and you are left with a difficult decision to move forward. 

Finding ways to generate and manage cash flow is crucial in maintaining a healthy financial structure to allow for continued growth and development and to support the decision to go green.  Depreciation expense is usually not the first idea that comes to mind when we think of ways to increase cash flow and demonstrate the viability of a development project.  However, commercial property owners of just about any size can increase cash flow and return on investment simply by focusing on and maximizing depreciation deductions. 

There are several strategies to achieve increased cash flow through depreciation with the two most relevant being cost segregation and the tax deduction for energy efficient buildings under the Energy Policy Act of 2005.

Maximize Depreciation Deductions Through Cost Segregation
The tax strategy known as cost segregation allows commercial property owners to accelerate depreciation on significant portions of the property resulting in reduced federal and state income taxes.  By deferring these taxes, a significant increase in cash flow is available for other investment opportunities. Real estate properties (and everything in them except movable furniture and equipment) are generally depreciated using a straight-line method over 39 years. A cost segregation study maximizes depreciation deductions by identifying building components eligible for depreciable lives of 5, 7 and 15 years using accelerated depreciation methods.

This is not simply a matter of classifying furniture or equipment to a shorter recovery period as most property owners (or their accountants) already routinely do. Items typically reclassified include certain flooring, finish millwork, cabinetry, specialty electrical and plumbing, and land improvements such as asphalt paving, concrete sidewalks, storm drainage and site lighting.

Green buildings can increase the development costs of a project by 10, 20 or even 30%, which are ultimately offset by decreased future operating expenses. The increased development costs provide a larger depreciable basis which allows even more opportunities for cost segregation.  Certain items included in green buildings can be more rapidly depreciated including vegetated roof surfaces, landscaping with native plant species, increased costs for certain renewable materials and stormwater management improvements.

The following table illustrates the financial benefits of performing a cost segregation study for a sample $10M office building and reclassifying 17 percent of the building basis to a shorter life. The table clearly shows the positive impact cost segregation has on cash flow, ROI and debt service.

Current Year Deduction Through Energy Efficient Building Tax Deduction
The Energy Policy Act of 2005 (EPAct) created a tax deduction for energy efficient buildings of up to $1.80 per square foot of building area. The deduction effectively categorizes a portion of the building costs into a one-year recovery period because it is all taken on the current tax return, similar to an operating expense.

To be eligible for the deduction, the building must meet energy cost savings levels relative to ASHRAE 90.1-2001 Energy Standards for Buildings Except Low-Rise Residential Building. The deduction is broken down into three categories including lighting, HVAC and building envelope, each of which permits a deduction of $.60 per square foot. Improvement costs in these categories must be greater than the potential deduction (area x deduction) or the deduction is limited to the actual improvement costs.

This tax deduction was recently extended so that the improvements must be placed in service prior to January 1, 2014.

A building that is pursuing the highest levels of green building rating through Leadership in Energy and Environmental Design (LEED) will most likely qualify for the full $1.80 per square foot deduction.  That would translate into a $360,000 deduction on the current tax return for a 200,000 square foot building, which provides a $144,000 tax savings at the 40% tax bracket. Similarly, if the same property qualified only for the lighting deduction ($.60 per square foot), the tax savings would be $48,000.

Both of these depreciation strategies can result in significant tax savings and increased cash flow and should be considered for almost any project.  Green buildings are especially good candidates for both due to their increased cost and specialty construction components.  Some experts say that the cost to go green will only rise in the future as demand for these spaces increases.  Now is the right time to make this investment in our environment and your future growth. 
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Jerome H. Kootman, CPA is Managing Tax Director for Cost Recovery Solutions, LLC, a specialized tax/engineering firm that provides cost segregation and other specialty tax services nationally to clients ranging from small businesses to Fortune 100 companies. He can be reached directly at 732-548-3855 or via email at jerry@crscostseg.com.

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