Cost Segregation for Real Estate Investment Trusts (REITS)

As with other legal entities, REITs may benefit from the increased cash flow provided through a cost segregation study.

Generally, REITs are eligible to derive up to 15% of their total rental income from personal property that is leased under, or in connection with, the lease of real property. Proper identification of personal property through a cost segregation study helps REITs maximize their current depreciation deduction, and thus increase cash flow, by appropriately assigning shorter class lives to assets.

Dividend Flexibility
Increased depreciation expense reduces overall current taxable income. Because REITs are required to pay out at least 90% of their taxable income in the form of dividends, lowering the amount required to be paid in the current period allows a REIT to better manage future dividends and also retain cash to fund upcoming acquisitions.

Shareholder Return
Lowering the required dividend payout may permit the REIT to pay dividends in the form of return of capital instead of ordinary income. Since dividends in the form of return of capital are untaxed until the shares are sold (and then only at the 20% long-term capital gains rate), shareholders achieve a better taxable equivalent yield. The following example illustrates this benefit:

The shareholder has a tax rate of 40%.

The share price is $25 and the annual dividend is $5.

Before the cost segregation study:
Return of capital percent: 0.00%
Dividend net of tax: $3.00
Taxable equivalent yield: 20.00 %

After the cost segregation study:
Return of capital percent: 50.00%
Dividend net of tax: $4.00
Taxable equivalent yield: 26.67%

Application
As with asset reclassifications from any other cost segregation study, new REIT properties placed in service during the current tax year are depreciated correctly on a prospective basis. MACRS properties placed in service in prior years are depreciated correctly on a prospective basis and also generate a negative 481(a) adjustment to income for depreciation allowable but not taken in the past.

SourceCorp is able to tailor the cost segregation study so that it is fully compliant with IRS rules, regulations, and procedures relating to these special entities.