Jeff Hobbs, Managing Director of Segregation Holding Limited, based in McKinney, Texas, discusses tax savings strategies for the ranch owner:
A Cost Segregation Study is a strategic, IRS-approved tax-saving tool. Cost segregation can be used by those who have constructed, purchased, expanded, or improved any kind of commercial real estate including ranches and farms. The study allows the ranch owner to take advantage of accelerated depreciation deductions and defer federal and state income taxes. Cost segregation uses IRS Modified Accelerated Cost Recovery System method of depreciation. MACRS is the acronym commonly used. Ranches have 9 categories under this system ranging from 3 years to 25 years. It identifies what ranch property can be depreciated.
Cost Segregation Process
The cost segregation process for your ranch is simple. An engineer conducts a site survey of your ranch. While there, pictures are taken of the ranch and measurements made to substantiate assets for the IRS. We review your ranch closing documents, appraisal, construction drawings & invoices, current depreciation schedule, and site plan. All information about your ranch is kept confidential. We break out all assets using the IRS Cost Segregation Audit Techniques Guide. Using MACRS we then classify each individual asset on your ranch according to those IRS guidelines.
Will My Ranch Qualify? If So, What Qualifies?
Short answer…YES! Cost segregation applied to a ranch or large farm is different from when applied to, say, an office building or restaurant. By different I mean there are factors specific to a ranch, not applicable to an office building. There is more to consider on the ranch or farm land itself. Land Improvements qualify for 15-year depreciation. These “land improvements” to the site would include privately built roads, fences, gates, security, electrical wiring, pumps and wells, irrigation systems, to name a few. Depending on circumstances, dams, ponds, and terraces would qualify. Of course, the land itself can never be depreciated. IRS Publication 225, Farmer’s Tax Guide, devotes almost three full pages to Depreciation, Depletion, and Amortization to farms and ranches. Buildings contain assets called “tangible personal property” and these qualify for 5-year accelerated depreciation. Examples of these assets are millwork, cabinetry, dedicated plumbing or electrical, carpeting and certain flooring, security/communications, secondary systems (e.g. backup power generator), to name a few.
What is Accelerated Depreciation?
Accelerated depreciation is the result of applying cost segregation. The assets we discussed above qualify to be reallocated from long-term depreciation periods (20 & 25 years) to short-term (5, 7 & 15 years). You already know what that means to your income taxes. It reduces them substantially. You keep more of your hard-earned money in your pocket
What Does it Cost?
Great question! A cost segregation study for a ranch will vary significantly according to it’s size and degree of improvements. Segregation Holding LLC is unique in how we deliver a cost segregation report. Our fees come with a guarantee. Our guarantee states “For projects over $500,000, we guarantee a minimum of 5 times the cost of our fee.” To date we have never been close. We regularly exceed 1000% ROIs, income tax credit vs. our professional fee.
SHLLC provides any ranch owner with a free, no obligation benchmark estimate. We have a simple client questionnaire. Armed with this information we can tell you how much you have overpaid your income taxes. We recommend taking our benchmark to your CPA. Discuss the merits of accelerated depreciation and how it will affect your personal tax situation. We can also file the appropriate forms with the IRS to get it back for you…at no charge.
For more information…
Want your questions answered now? Call us at 972-865-9050 or 972-897-8019.
We’re here to help get your hard earned money back in your pocket!
Water & the American Landowner: Examples of Forward Thinking in Water and Land Conservation
The following article is the third in a three part series where Open Fences Magazine is highlighting innovative land and water conservation practices by landowners throughout the United States. In the first article, we introduced a rice farmer in Texas who has conserved 40% of his water usage and increased yields with a technique called precision grading on his fields. In the second article, we introduced Beartooth Capital, an investment group out of Montana that acquires degraded ranch properties and conducts ecological enhancements to increase the value of the investments.
For this third article, we are going to introduce a land management and business tool called environmental banking as a way for property owners to generate substantial income from their land while simultaneously improving the health of the environment.
Environmental banking can basically be described as the creation of a natural resource commodity that is then sold to a customer, usually a developer or polluter who is required to pay compensation for the impacts associated with their activities.
For example, if a developer had plans to build houses or roads on a parcel of land that included wetlands and these wetlands were impacted from the construction activities, then by regulations set forth by the US Environmental Protection Agency through the Clean Water Act, the developer would be required to compensate for these wetland losses. The US Army Corps of Engineers would have jurisdiction of the process and would be the agency responsible to ensure the compensatory actions were met.
To further the example, say this developer impacted one acre of wetlands, then they would be required to mitigate for at least one acre of newly built wetlands, but oftentimes the Army Corps of Engineers will set the ratio at 2 acres to 1 or even 3 to 1. This process can become very expensive as they will have to pay for the design, construction, monitoring and maintenance of the mitigation wetlands. Plus, they are not off the hook until the Army Corps of Engineers certifies them as successful wetlands five years after construction is completed. This can be a long and expensive process, especially if their mitigation efforts are unsuccessful because they will have to start over.
However, there is another better option for this developer, which would be to purchase credits from an existing wetland mitigation bank instead of going through the process of doing it themselves. This article isn’t to show how developers and polluters can get out of having to mitigate their actions, but rather to show how ranch owners can provide an environmental benefit and take advantage of a growing market.
A wetland mitigation bank is where a landowner has built wetlands on their property for the purpose of selling the credits to people like this developer. The owners of the bank must go through a process to have the wetlands certified to ensure they function as a healthy ecosystem, but once they do, they are able to sell these credits on the market to customers within their area, usually based on the watershed where the wetlands are located. This is almost always substantially more cost effective for the developer and provides a much healthier and functional result on the ecosystem scale.
This isn’t just a better option for the developer because on the other side of the deal is that landowner who understood that they could create a commodity that could be sold in a real market that is producing substantial revenue streams. Some estimates have shown that the average cost to construct a wetland mitigation bank could be in the range of $10,000 to $30,000 per acre and would include the design, planning, and construction costs. However, these estimates also show that the average cost of the sale of the credits can range between $60,000 to $100,000 per acre depending on the supply and demand forces as well as the intensity of development within a certain area.
Some of the resources required for the wetland bank would, obviously, be to have land, appropriate soils, a good water source and the rights to use this water in this manner. If the resources were available, then it could make a lot of sense to explore the option of creating an environmental bank as another source for potentially substantial income and to create a real and lasting benefit for the environment. For ranchers and farmers who already have the natural resources available, but not the financial resources, they could explore the option of having an investor provide the capital costs to get the project going and share in profits from the sales.
Although the example that we discussed highlighted a wetland mitigation bank, there are many other types of environmental banking opportunities that a landowner could potentially initiate. These banks are becoming a major tool for the entrepreneurial land owner and investor. As with any business decision and investment, they will want to explore the potential of the commodity market they would be entering and identify the opportunities and constraints on their land.
Some of the other environmental banks that have been initiated are as follows:
- Wetland mitigation banks
- Carbon banks
- Energy banks
- Endangered species habitat banks
- Land development banks
- Water and water quality banks
To learn more about environmental banking and to see if developing a bank would make sense on your ranch property, please contact Tom Roberts, president of Western Lands – Ranch Restoration Services at 720-936-9973 and also visit their website at www.western-lands.com.
Western Lands – Ranch Restoration Services is a company with offices in Parker, Colorado and Bozeman, MT. We provide design, project management, and owner’s rep services for the owners of legacy ranch properties throughout the United States.
- Necessary Knowledge
When the client lacks the necessary knowledge of the process, they tend to forego control of their investment and utilize the building team as their only source for guidance. It is important the client remembers even the most ethical firms are in business to make a profit. This means they will often be self-serving; putting their own interests first and the client’s interests second, even when the client has given clear direction it is not always followed. The best defense is for the client to become knowledgeable about the building process. From architectural contracts and budgeting to project scheduling and standards of building practice, it is imperative that the client stays informed at all times. This knowledge offers protection of their investment.
2. Selecting the Lowest Bidder
Clients tend to feel if they have a group of reputable, highly recommended builders vying for their project, it really comes down to price. It is generally true that a group of comperable builders will produce a similar level of quality in their construction practices. In fact, it can often be hard, looking at the finished product, to tell which builder the client utilized. This being said, it is understandable why many clients choose the lowest bidder. However, choosing the lowest bidder can be a recipe for a painful and unpredictable client experience. The client has to keep in mind the hard costs of a project do not vary. When comparing bids, the client needs to understand that the highest bidder might actually be the one firm telling them the real cost of the project. The lowest bidder may not be telling the client the real cost of the project and plans to “change order” the client as needed. Most of the time, at the end of a custom home project, the client will have paid about the same amount of money to reach completion; no matter which builder they selected. It is always better to know from the beginning the true cost to build.
3. Signing an Open Ended Contract
Being fair to the builder, the client can make the cost difficult to pinpoint because of the fluid design styles many architects enjoy using. Due to this fact, builders have learned to write their contracts with open-ended language not specifying site condition costs, quality standards, timely budget reports, or schedule compliance. Clients may need to have an attorney that is familiar with construction or an unbiased expert look at the contract to find any holes that the builder may have left for their own protection. Some of the contractual terms to be weary of are “substantial completion”, “warranty period”, “required start date”, “market price”, “existing conditions”, “allowance items”, “final payment”, “contingency budget”, “general conditions”, and “change orders”. These terms are not necessarily bad, yet they should require further explanation in the form of a detailed addendum to the contract. Once signed, the client pays for anything unexpected not in the contract.
4. Inadequate Site Visits Before the Architectural Design Phase
Clients often make the mistake of thinking that a couple meetings on the property will be enough, especially if they live far away. This can be a costly mistake. When the client fails to visit the site with their building team repeatedly before design begins, the client is opening themselves up to unforeseen costs as the project progresses. This mistake can also impact the life cost of the property. It is crucial that the client has a full understanding of the conditions, potential obstacles, and general surroundings so they can speak in an educated manner regarding actual costs. The client should spend time on the property at different times of day to see how the sunlight falls on the building envelope. Considering the amount of solar gain the design of the house will incur enables the client to know if they should make changes to their design plans. For example, the client might modify the design to provide more or less interior shading, adjust the specifications of the heating or cooling system, change the type of glass used in their window package, or simply increase the interior design budget to use heavier window treatments. The replacement cost of sun-damaged artwork or antique furniture should be considered in the client’s long-term cost projections. Often times, expensive pieces cannot be enjoyed because the sunlight beaming in through a big viewing window is too damaging. This can be very frustrating. Regarding the exterior elements, the client should spend time on the property at night to find out if there are any loud noises from a nearby road or neighbor, giving cause to design the master bedroom on the opposite side of the house, relocating the outdoor fireplace to a quieter location or adding extra money to the landscape budget for a berm or row of trees. This may seem like a big commitment, though it will save costly change orders during construction and disappointment when the client moves into their new home.
5. Waiting Until Mid-Project to Engage The Interior Designer
Some clients feel the interior designer does not need hiring until construction is in progress. Other clients understand the importance of hiring an interior design firm early on, but do not include them as part of the building team, rather, bringing them on site as an independent part of the process. Both of these strategies can end up costing the client unexpected, large sums of money. The interior designer is integral from conception to completion. For example, as the architect is placing the thermostat layout on their blue prints, they will need to know the interior designer plans to place a large painting on a particular wall and cannot have any obstructions. There could also be a case where the client has a heirloom furniture piece they have asked the interior designer to incorporate. Consequently, the architect will need to know about this piece and its intended use from the beginning. They may decide to design a niche, optimizing the flow of the room. Another example might be remote controlled window coverings. This requires extensive planning regarding the architects design, the structural engineer’s design, the electrician’s pricing and scheduling, and the builder’s budget, sub-contractor sequencing and maintaining the project’s schedule. If the interior designer selects a heavy chandelier for the great room, the builder needs to be able to provide a way to attach the fixture. There may be a hidden steel beam running across the exact place where the chandelier needs to hang. It will be costly to install and the builder needs to have this in the budget. Knowing the rippling effect of interior design decisions is crucial to avoiding change orders, maintaining the budget and keeping the schedule.
By avoiding these five common mistakes, the client can build strong alliances with their team and increase their enjoyment of the building experience.
Austin Rector, President of Stoa Management
David Fisher of Creative Real Estate Strategies Explains
In my 30 plus years in practice, one of the toughest things that has had an impact on my ability to make proper decisions for my clients is understanding the emotions and realities of the situation. For example, understanding that the stock market bubble in 2000 was coming to an end and that the days of making fairly easy profits in the market were over, leaving the stock market was a difficult but correct decision to make. But we did and we moved on. Although the profits were real, they were still “on paper” and could be moved to another opportunity in a given moment.
Real estate is a completely different reality. I remember many years ago a client telling me why he only invested in real estate and not the stock market. He said that a stock certificate is a piece of paper that could become worthless one day but with his real estate, he could walk on it, touch it, improve it and it will always be there. That’s tough to argue with because he’s right. But when dealing with large properties like legacy ranches, the emotions and realities are magnified dramatically. I remember when I moved out of state years ago, I had to relinquish my driver’s license in favor of a driver’s license from my new home state. At that time, I had held that license for 30 years and when I handed it over, I felt like I was losing a member of the family. And that was just a license.
When owning a property for a long period of time, it becomes a member of the family. It’s nurtured and it grows up like a child. Those seedlings have now become wonderful trees. The pond brings back memories of summers past. The years have brought additions and improvements to the ranch. The kids no longer inhabit the long ago built tree house but now it’s the laughter of the grand kids. But as with life, there comes a point when it’s time to move on and allow another family to buy the property so they can create their future memories. Moving on is always somewhat painful and stressful so it’s the obligation of the advisers to alleviate as much of the emotions as is possible.
One of the unforeseen disappointments in selling a legacy property that has been part of the family for decades is the impact of taxes on the sale of the property. Capital gains taxes, state taxes where applicable in 43 states and depreciation recapture can dramatically reduce the sales proceeds to the sellers and quite often, can cause problems in the negotiating process for the property. The buyers may want to make improvements to the property and thus may be limited in the offer they are willing to make while at the same time, the sellers need to maximize the proceeds from the sale since those proceeds may need to be invested to provide a retirement income for the rest of the seller’s lives. And of course, let’s not minimize the impact of the time, efforts and money spent by the land brokers to bring the negotiations to a successful conclusion for all parties involved.
Although there are several different ways to sell a property, one approach that is becoming quite popular is the Deferred Sales Trust. The DST was created to allow the seller of highly appreciated real estate defer the capital gains tax, state tax where applicable and some depreciation recapture on all of the sales proceeds for as long as the seller would like. In its simplest form, the DST is a tax compliant installment sales contract with a third party trustee. The Deferred Sales Trust is a trademarked name that’s based on the tax code including Section 453 so many CPA s and attorneys are familiar with the code but may not be familiar with the trademarked name.
When the price of a property is agreed upon and the property comes to the final closing, the property’s ownership is transferred to the DST and then sold to the buyer almost simultaneously. The proceeds are sent to the third party DST so there is no constructive receipt to the seller. The buyer now owns the property and the proceeds are in the DST for the seller’s benefit. The proceeds are then invested according to the wishes of the seller and through the use of an installment sales contract, the seller now receives monthly taxable income from the DST. The seller can receive either income only for whatever length of time the seller would like or a combination of income and a portion of the proceeds each month. Capital gains tax, state tax and some depreciation are not taxable to the seller until the time that the sales proceeds are actually received.
Obviously, the Deferred Sales Trust can be a valuable tool to all parties involved. The land broker can introduce the DST to his client, the seller as a way to maximize the value of the sales proceeds. At the same time, the DST can be introduced to the buyer from either his land broker or by the Farm Credit Services firm that would like to make the loan on the property assuming they will be involved in the funding process.
At the same time, the DST offers other potential opportunities in the buying/selling process. In this particular example, the family would like to sell their ranch and move on to other opportunities so the DST provides them the ability to do so. However what if the client would like to sell their property but attempt a 1031 exchange. Once again, the Deferred Sales Trust can provide all parties involved with opportunities.
One of the biggest concerns in completing an exchange is the time frame imposed by the IRS. First you have the 45 day identification period and then another 135 days to close on the property. In addition, you have other potential problems like dealing with the loan to value of the properties as well as loan financing of the replacement property. Needless to say, there are more obstacles to completing an exchange then there are predators when a salmon swims upstream to spawn. At the least the seller doesn’t die at the end of the process. The DST can be used as a default when for whatever reason during the 1031 time line, the exchange falls apart. Instead of the proceeds being sent to the seller when the exchange fails and becoming immediately taxable, the proceeds are sent to the DST so again, there is no constructive receipt to the seller. As in all situations, the proceeds are invested according to the desires of the seller but just as important, both the seller and his land broker are still “in the game” to buy more real estate. However, now since there is no longer an exchange situation, the seller is free to buy whatever property without concern for having to follow 1031 regulations. Everyone wins.
There are numerous other applications for the DST but these 2 examples are probably the most widely used. For those that have charitable intent, the DST can be used to make a gift to charity that might be more appropriate than using a charitable trust. The DST provides a wealth of opportunities for land owners, land brokers, CPA s, attorneys, qualified intermediaries and rural ag lenders. A well-known Hollywood legend once said, “I’m proud to be paying taxes in the United States. The only thing is– I could be just as proud for half the money”. All he had to do was call me.
David Fisher utilizes 30+ years of experience in insurance, investments, estate planning, taxation and interactions with nonprofit organizations to offer real-world solutions for his clients.
Visit Creative Real Estate Strategies website.
David also has a tremendous article featured in Open Fences Magazine that is full of more information about DST and how their unique characteristics can help you get more out of your sale. To read the the article, click here.
Buying a ranch in the Rocky Mountain West and building it into your dream property is a wonderful experience and knowing a few things up front can make creating your vision even more enjoyable. I have found that many of my clients are surprised by the cost to build on a ranch, so I would like to explain the primary factors that drive these costs and provide a brief explanation for each of them. The primary factors are remote locations, engineering considerations, extreme temperatures, and necessary professionals.
Building in the Rocky Mountain West requires pulling from a workforce that is most often far from the location of the building site. I have seen cases where the general contractor traveled as far as 250 miles to build on a ranch. This is often necessary to find a company that possesses the business infrastructure, workforce and full understanding of all that a complex, multi-million dollar project entails. Using a workforce that is far from their home office adds cost because it requires housing, meals, transportation and increased wages for the workers. This is money well spent when you are getting a company that understands what it takes to do a remote project properly.
Much of the Rocky Mountain West is located in the Intermountain Seismic Belt. The potential for earthquakes requires extra structural measures be taken. Montana, for example, has recorded an earthquake with a magnitude of 7.5. Though this magnitude is rare, many smaller quakes occur each year, giving cause for structures to be designed and inspected by a professional engineer. Many structural elements are required that hide within the floors, walls and ceilings and add cost, though they go unseen.
Considering the fact that some areas in the Rocky Mountains receive over 400 inches of snowfall annually, roof structures must me designed very precisely. Calculations must be made and engineered specifications given for each structural component that goes into the roof system, often times requiring expensive steel I-beams and structural lumber to be utilized.
Wind is a defining part of the Western landscape, with gusts recorded over 100 mph. It blows through the valleys and makes it way up to the peaks. This becomes a very relevant concern when it comes time to build. Think about those long-abandoned barns and houses that dot the landscape of the West. They all lean with the prevailing wind. This is why modern building practices incorporate specified structural elements to hold the buildings upright and intact. These elements, though hidden, add cost.
When building on a mountainside, there must be geotechnical testing performed. This will give an analysis of the sub-surface conditions and let you know if the soil is suitable for a building site. Sometimes the soil is structurally sound. However, the soil on mountains can tend to shift, so this will require specified action to be taken in order to build a proper foundation that will hold the structure in place. In some cases, the existing soil must be removed, down to the depth determined by the engineer, and then replaced by structural soil. In other cases, the engineer will decide to leave the soil in place and do a micropile foundation. This is where many structural steel tubes are drilled into the ground until they hit bedrock, then they are filled with grout. The traditional concrete foundation is then built on these micropiles. This allows the soil under the structure to shift, while holding the structure in place. Either of these foundational elements adds to the cost.
The temperatures in the Rocky Mountains will range from sub-zero to over 100 degrees. It is common to have significant swings in temperature over short amounts of time, the ground freezes as deep as 60 inches, there’s high wind, heavy snowfall, and spring melting causes the streams and rivers to flood and all of these factors require that buildings are constructed to the highest, most modern standards available. Considerations such as waterproofing, insulation, cold roof systems, smart framing, ventilation, humidification, flood control, soil erosion control, waterway protection and road placement are just some of the countless things to consider. These factors are in addition to what a normal building project would require and consequently increase the cost.
The common progression when realizing ones dream of owning a ranch is to contact an attorney, buy the land, hire an architect, hire a land and stream consultant, and finally hire a general contractor. However, this system is flawed in many ways. This line of thinking requires the buyer to have time to focus all of their energy on their ranch project. It assumes the buyer is fully up to date and educated on everything from soil conditions, to grazing right leases, to best construction practices, and the list goes on. The buyer is often wrapped up in “learning as they go” and find themselves frustrated at how all-consuming the actual work of realizing their dream of owning a ranch quickly becomes. The best way to maintain control of the project is to bring in all of the required professionals from day one. Much of the team should be assembled before or at least in conjunction with the ranch going under contract. This is necessary to help the buyer understand the viability of their project and if the land is suited to fully meet their requirements. A full team of professionals should include a ranch broker, land attorney, CPA, tax attorney, cost segregation engineer, agriculture and livestock consultant, environmental engineer, land and stream consultant, architect, general contractor, and an owner’s rep/program manager to oversee the entire process. At first this long list of professionals may seem like added cost, but at the end of the day, these professionals are focused on minimizing the cost of the ranch in both the short and long term through income taxes, real estate taxes, construction costs, and general overhead of the ranch operation.
The best way I can put it, is that you have to look at the life cost when you are buying and building in the Rockies. This is not the kind of place where you can just throw together a simple building. You should assemble a team that has experience in this type of climate. Find resources that will provide you with detailed questions to ask each of them. Have them walk you through their quality assurance process and ask them to tell you some things they learned from the last house they built or designed that will make your project be their best one yet. Finally, ask them why they live in the Rocky Mountain West. Your team has to not only understand, but share your passion, or they will never be looking out for your best interest.
Austin Rector, President
STOA Management, Inc.
"I have worked with Austin Rector and can’t say enough good things about his skills,
his competence, his character and his 'interpersonal grace'."
- Jonathan Foote, Architect