Chris (00:02.442)
I want to thank you for joining us today. Today we’ve got a pretty neat topic. It’s one a little bit outside of our typical HR world. But we’re going to talk about some tax incentives because we know that cash flow is so important. And so one of our partners that we’ve worked with for many years is CTI and they focus on providing tax incentive services for businesses. And so today we’ve got Carrie Gibson, who’s the managing director

of the consulting practice, and also Bill Mark, who’s the director of the cost segregation area. so we’re going to talk a little bit about cost segregation and R &D tax credits. So I appreciate you guys joining us.

Carrie Gibson (00:47.286)
Thank you. Thanks for having us.

Chris (00:49.512)
Yeah, no, absolutely. I appreciate you joining us. so, you know, I think maybe what we do is we kind of start, we’ll start with the cost segregation. That’s the fun one, right? That’s the one that I know more about. So when we talk about cost segregation, tell me a little bit about where that comes in for a business owner. What is a cost segregation? And then we can kind of talk about how that does create cash

Bill Mark (01:18.217)
Sure. I’ll start by kind of this. without a cost -sake study, every income -generating property has a depreciable basis associated with it. If it’s a commercial property, it’s going to be depreciated on a straight line method over 39 years. If it’s a residential rental property, it’s going to be depreciated again over a straight line method.

over 27 and a half years. Okay. So you’re essentially taking that basis of your property dividing it by 39 or 27 and a half. That’s how much depreciation you can take advantage of and apply it towards your taxable income each year. So you can have that very set limited amount. Okay. What a cost irrigation study does for you, it’s essentially a detailed engineering analysis where we’re going to take your property and our goal is

carve out the personal property from the real property. Personal property is gonna be everything that we put into a shorter class life of typically five, seven, or 15 years. And then your real property portion is gonna remain at that 39 or 27 and a half year class life. But those shorter class lives that we’re putting the personal property into, that’s front loading the depreciation for

You have much larger amounts of depreciation to apply towards your taxable income in the early years of owning that property, therefore freeing up cash flow for you. That’s the whole primary goal behind what cost activity does for you.

Chris (02:58.698)
Okay, so essentially it kind of comes down, we’d rather have a dollar today than a dollar in 39 years. Is that kind of the way it

Bill Mark (03:04.931)
Absolutely. It’s time to your money.

Chris (03:09.076)
So, okay, when we talk about the cost seg, where’s a good balance for that? So, like we work with a lot of grocery stores and hotels and groups like that, which obviously they’ve got massive amounts of money in their buildings. Where’s that kind of demark line? Is this good for any building? Is there kind of, well, if it’s under a million dollars in cost, probably doesn’t make sense. How does that work?

Bill Mark (03:38.458)
You’ve hit it on the head there pretty well. Yeah, there’s just a couple of key things that I’ll tell clients or CPAs when they’re trying to identify candidates for a cost -effect study. The basis being a million dollars is typically the first thing that I’ll tell them. That’s the minimum that we like to see in order for a study to start making sense.

That’s where we can start generating enough benefit for the client to make it worth it for them to pay for a cost -effect study. That can vary a little bit depending on the building type. We do a lot of residential rental homes for clients as well. A little bit harder to do that million dollar number with residential homes. Not so much in California here, but in other states it’s a little bit harder. But we’re able to work a little bit lower basis.

with certain building types, but just in general, I’ll tell people million dollars is what we’re looking for. When it comes to, does it have to be any particular type of building, retail, office, It doesn’t really matter to us. We do studies on every type of building that you could imagine. As long as it’s generating that tax liability and there’s enough basis to work with, we can do a cost -save study on it.

One of the other key factors that I like to mention is it needs to be something that they plan to hold on to for a number of years. And when I say that, a minimum of three to five years. You don’t want to be looking at costs if you plan to be flipping a property within a year after you purchase it. You’re always going to have recapture when you sell a property, whether it’s a year down the road or 15 years down the road.

But the idea is, you know, if you wait at least three to five years, that’s giving you enough time to take advantage of that depreciation that was generated by the cost -setting study. It’s giving you time to reinvest it, pay down debts, versus if you do a cost -setting study today, sell your property next year, you’re going to pay that recapture tax. And you didn’t really give yourself enough time to take advantage of using the cash that was generated. So I tell

Bill Mark (05:59.057)
minimum hold three to five years and million dollar basis.

Chris (06:03.836)
Okay, okay. So we do the cost seg, we figure out, we’re gonna expedite that depreciation right or accelerate it. How does that show on my tax return? Is that dollar for dollar? How does that work as far as going against net income?

Bill Mark (06:24.009)
So it’s a deduction and it’ll just be deduction towards your taxable income there. It’s not a credit, so it wouldn’t be dollar per dollar. It’s gonna show up on your depreciation schedule instead of having everything in just one item at 39 years. You’ll have a 39 year item, a 15 year item, maybe a five or seven year asset class on your depreciation schedule. that’s how it’ll show up on your tax.

Chris (06:49.706)
Okay, now that makes sense. I guess what happens too is over time, we depreciate that carpet. And then what we’ll do is we’ll go buy some more carpet, and it’ll go back on the asset schedule, which I guess works. So otherwise, what happens is you’ve got that original carpet at 39 years, if you don’t do the cost seg. And then you get the new carpet that’s on there for, well, I know you’ll probably get

Would you get to write that off on that for initial 39 years? Can you pull that out? Or is it just a big

Bill Mark (07:22.599)
You can. so that’s another, I’ll say, advantage to having a caustic study done. If you have a property where you know you’re going to be making improvements to it down the road, what that caustic study will do for you, if it’s detailed enough, is, it should separate out all the components of the building and assign a value to those, whether it’s the carpet, the windows, the doors, the drywall partitions, whatever it is, the

So if you end up replacing those items down the road, that cost -save study is going to help you identify the remaining depreciable basis of that asset and allow you to write that off if you replace it down the road versus having to keep it on your books because you have no idea what the value of it is. So that was a great point. It good question.

Chris (08:09.514)
Right, okay, that’s just another benefit of doing that. I know about this much tax. So a lot of this I’m not that familiar with. So we know that it comes out as a reduction of your taxable income. are there other, I know there’s accelerated depreciation that you can use, I think, what is it, 179?

depreciation, things like that, but that’s more tangible. How do these things live together? How do these different types of depreciation live

Bill Mark (08:50.217)
It can get a little complicated and that’s why you do need to hire the right. Test consulting firms that we navigate those issues because you’re right. You have a cost irrigation study that could be applied to a particular new construction or renovation or purchase. You also have one city not expensing that you could consider if it’s a renovation or some sort of new construction type project.

There’s qualified improvement property aspects and rules that come into renovations that have to be considered. You have 179D energy efficiency credits, you 45L tax credits. A lot of those things can be combined together to maximize your benefit, but you need to know how all those things play together. And that’s why you hire a firm like us to do that. We have a property incentives.

Chris (09:30.634)
That’s what I

Bill Mark (09:49.959)
department here at CTI. So we don’t have just a cost seg division. We have cost seg. We have folks that do 179D and we have folks that do 45L. So we do all that in -house and make sure it’s properly coordinated to next much better.

Chris (10:05.542)
Okay. Yeah, that was one thing I was going to ask is if you guys kind of did all those different components where you, you know, it’d be a lot easier if you had one person or one entity that did those versus having to deal with a lot of different people to do

Carrie Gibson (10:19.734)
Yeah, absolutely. The left hand needs to be talking to the right hand there for sure.

Chris (10:23.402)
That’s right. No, absolutely. So let me ask you this. Just as a, if I’m a business owner, one of the things I like to know, and I know this would be very hard, but what is kind of the cashflow benefit for somebody that has, and I know it probably depends on the breakup, but if I have a $10 million building, I mean, am I

Chris (10:53.075)
million dollars the first year. I’ve seen some examples on your website. So I didn’t know, what are they looking

Bill Mark (11:02.121)
Right, so we need to know a few general facts. The type of building does determine what kind of percentage allocation would typically fall or would typically get that type of property when it was purchased because you have the bonus depreciation rate that comes into play. I did have an example set up kind of ready to talk about.

I’m kind of give you some facts about it and I’ll tell you kind of the benefit that we expected for this project. let’s say we had a 250 unit multifamily property purchased in 2023. Okay. Let’s say the depreciable basis on that property was around 21 million dollars. All right. The numbers that we expected to get in terms of additional depreciation for the 2023 tax year was about

$4 .9 million of additional depreciation that that owner could apply towards taxable income as a result of the cost -sake study. We also like to present our benefits in what we call a cash flow benefit, and we simply take that depreciation that we estimate and multiply at times the 37 % max tax rate. So in this situation, we have $4 .9 million depreciation.

and about $1 .8 million of cash flow generated by this

Chris (12:33.372)
Okay. So that, and then they can take that money, they can pay down their debt, which then they save money on interest. They can invest it, whatever that may be. I, you know, I, like I I, I know about this much tax, probably that much tax, but to me, the cost sags are no brainers. They really are. I’m a, I’m a CPA by trade. So I’ve dealt with some of this before. And to me, they’re always, they’ve always just been a no

Bill Mark (12:42.663)
Yeah, they can do it.

Chris (13:01.492)
to do. If you own a building and it economically makes sense, know, that million dollar or more benchmark, I think they’re just no brainers.

Bill Mark (13:12.169)
I would agree with you 100%. To everyone.

Carrie Gibson (13:13.842)
agree.

Chris (13:14.698)
Well, is there anything that I missed on the cost segregation or anything else you’d like to talk about on that?

Bill Mark (13:26.185)
I don’t think so. I we hit the major points. Million dollar minimum, know, something they want to hold long term. could fit any type of building. to be anything in particular. I guess there is one other thing that thought of. It doesn’t have to be something that’s a current year purchase or a current year improvement. This could be a property they’ve owned for 20 years and that potentially could still be a benefit there.

Now, the older it is, the larger the basis we to be working with, we do these look back studies all the time as well on properties that clients have owned for several years. There’s still opportunity to get that catch up depreciation that they’ve missed for all those years building the

Chris (14:11.068)
Okay, now, and can this be carried? So if a business, you know, the economy’s rough, if the account can it be carried back? Can it be carried forward? As far as the

Bill Mark (14:23.113)
So if you don’t use or if you don’t need all the depreciation for, let’s say, the 2020 tax year, you generate $4 .9 million of depreciation for that one particular client for that multi -credit property. If they don’t need all of that, it does roll forward until they use it up. So that’s not

Chris (14:39.41)
Okay. Okay, perfect. No, that’s great. Well, no, I appreciate that. And like said, I think those are just no brainers. I really do. And then also, we wanted to talk a little bit about the R &D credit. And this one, I think is interesting to me because, you know, I think a lot of people when they think about the R &D credit, it’s like, well, okay, that’s got to be a manufacturing company. Right? Because it’s got to be somebody or life sciences.

or something like that when it really does it. It relates to a lot of different industries. so, us a little bit about what is an R &D credit? What kind of industries or what activities can you use for that credit? Just a little bit of background.

Carrie Gibson (15:26.092)
So I think the R &D credit is probably one of the most misunderstood credits. The name definitely causes folks to self -censor. I think the name you think of more of the Webster definition of R &D, when you hear that, you’re thinking test tubes, speakers, lab coats, patents lining the wall. And while those are great candidates for the credit, they can certainly be a recipient of an R &D credit.

It’s not how the IRS defines R &D. So initially when the credit was started in 81, you know, under Reagan, that is who the credit was designed to reward. So I think a lot of folks and even practitioners still live in maybe that old definition. Around 2001, the credit shifted and was expanded to include companies specifically in manufacturing and fabrication, but also architecture, engineering, maybe some specialty construction.

software and technology. But really the name of the credit stayed the same, but how a company qualified and the threshold that you had to meet is what changed. And so initially to claim a credit, you had to have a patent on the wall and you had to meet a very heightened test that was considered, it was called a discovery test.

And so had to prove that this was something that was new to the world. It was a new to the world concept, which is where the patent comes in. But under the new rules that happened in early 2000s, it expanded

and to companies that were developing or improving products that were just new to them. So it’s new to the taxpayer, not new to the world. And so that means if you’re making widgets and your neighbor’s making widgets, you’re both entitled to some version of your own R &D credit. And so that really expanded the type of companies that can qualify. And overall, the congressional intent behind it was to keep technical jobs in the US, to hire technical labor.

Carrie Gibson (17:25.376)
to do this type of work really more of an on -shoring credit as opposed to rewarding offshore manufacturing or engineering, things like that. So, yeah.

Chris (17:34.802)
Okay. No, go ahead. Go

Carrie Gibson (17:37.884)
So that really is more of the background today when we look at eligibility for the credit. Definitely the industries that I mentioned before, so manufacturing, fabrication, architecture, engineering, construction, software and tech. But then there’s a number of industries that kind of fall under those five. Think, know, breweries and distilleries and wineries are also great candidates. You know, all different disciplines of engineering can be great. So it could be, you

electrical engineering or industrial engineering, civil engineering, those are all also great candidates. But of course, we don’t want to forget about pharma and life science and biotech and things like that. So industry wise, it’s very broad. But overall, what we’re looking for companies that are designing, developing, building or producing things. And that usually is a good indicator that some level of R &D is happening.

typically start there and then kind of work our way down to better understand exactly what the company is doing and to what extent. So are you doing the right work that would qualify? So I had mentioned before, this would be folks that are maybe improving an existing product or they could be developing new products. They also might be tweaking an internal process in an effort to make something faster, cheaper, stronger. Those are also really good indicators of R &D activity happening.

The biggest thing that I also think gets often overlooked is the credit isn’t dependent upon a project being successful. So this could also be failures. It’s actually incentivizing the failures. We want you to attempt something new or maybe you are.

an architecture firm and you are submitting a design and you don’t win the bid, that work is still qualified work for the credit, but it’s okay that you didn’t win the work. So that’s another area I like to kind of make a point of noting.

Chris (19:40.554)
No, that makes sense. one thing I read too when I was getting ready for the podcast is it’s great for small, for new businesses too. For startups, because a lot of what they’re doing is new, right? They are developing things. And in my research, I found an article on Forbes that 38 % of these businesses fail because they don’t have capital. And this is a way to tap into

Carrie Gibson (19:50.656)
for startups, yes,

Carrie Gibson (20:09.012)
Yeah, no, you bring up a good point. So the credit itself is typically claimed, or it is, I shouldn’t say typically, it’s claimed on your federal income tax return. And traditionally, you would use that to offset your federal income tax liability. Now for a startup, like you’re mentioning, that’s usually pre -revenue,

not making money. This is something that happened just about 10 years ago or so, maybe a little less than that.

They looked at this, they essentially made a startup provision to the credit and said, we realize that these startup businesses are doing the qualified work, but they’re not profitable. So they can’t actually use the credit. They can generate the credit, but then it sits on a carry forward schedule. And is that really a value to them? And so the startup provision allows a business that meets a certain criteria. So under 5 million in revenue, under five years old, you can actually claim the credit on your

income tax return, but then make an election to use the credit on your payroll tax return so it can offset payroll taxes annually. And so that’s where that startup provision comes in and they can actually find benefit and use it to offset payroll tax as opposed to federal income tax.

Once they do start making money and they become profitable or they run out of that small business qualification where they can make those elections and they do have to start using the credit in the traditional form, which is to offset federal income tax liability, but they would have potentially additional carry forward credits from the payroll, from generating it to offset payroll taxes that they can still use, which is really interesting.

Chris (21:55.26)
Okay, yeah, so that would be a great way for them to create a little cash flow by doing that.

Carrie Gibson (22:01.632)
Well, for sure. I think startup businesses should be at least aware of it as well, even if it is something that they can’t use. I think education and being aware of these programs, whether it’s cost seg or even research and development, knowing that it exists so that if you’re you you pivot or something grand happens to your business, you’re aware of these items and things that you should be looking

Chris (22:24.703)
Yeah, no, absolutely. And again, when I think of R &D credit as just somebody on the outside of that, I generally think it’s got to be these big businesses, right? We’re talking about Microsoft and, you know, Caterpillar or whoever that are out here building these things. It’s really anybody can do it, can be eligible.

Carrie Gibson (22:44.266)
Yeah, I mean, we certainly have large publicly traded companies as clients, but I would say the majority of our clients, truly the bread and butter of the businesses we serve are small to mid -size businesses that are typically a flow through entity, handful of shareholders, you know, that just don’t quite realize that this work that they’re doing every day actually qualifies for the credit.

Chris (23:08.586)
So that kind of leads me back to the question that we had on the cost side. Where’s that kind of benchmark that says, it really needs to be above this to really make a

Carrie Gibson (23:20.47)
So the biggest driver, we’ve talked about activities and how a company might qualify for the credit and the type of work they need to be doing, but ultimately we have to translate those activities into dollars. And so biggest driver of the credit is payroll, US -based payroll. You can also look at for purposes of the credit, supply costs, outside contractors you may use.

and any potential like cloud computing or hosting expenses. So you would look at all of your expenses in those four categories. But let’s back up to just the payroll side because that’s the biggest driver. You really want to make sure that the business that you’re looking at actually has payroll and how much are we looking at? Now, I like to say maybe a million dollars in payroll is a good number to start with.

But I also want to clarify that every business is a little bit different. So if you look at a software and tech company, they are more heavily weighted in technical labor, where they’re hiring, maybe they’ve got less warm bodies, right? They’ve got maybe 10 people making $100 ,000 a year at a million dollars in payroll. And then you’ve got a manufacturing firm on the contrary, right? On the other side, where they’ve got less technical people, more labor. And so,

the percentage of their skilled labor is lower than let’s say on a software and tech company, right? So we can typically on a software and tech side work with maybe a smaller pool of wages because it’s typically more technical wages. Does that make sense? Okay. But.

Chris (24:50.524)
Okay. Yeah. Yeah, I think so. And so, but really, I guess it sounds like to do these, you really need what, like six figures? Is that kind of in cost to a million dollars?

Carrie Gibson (25:01.548)
I’d say that’s probably a good place to start. would say a million dollars in wages is probably a place to start. But again, if you’re maybe a heavily, highly skilled percentage of your workforce is, your workforce is technical, then I would say maybe we can work with something a little less than that. Yeah.

Chris (25:21.106)
Okay, okay, now that makes sense. That’s helpful. And it sounds like this is a credit. So this is a dollar for dollar, right? Okay.

Carrie Gibson (25:29.228)
Yes, sir, it is. Yes. And the credits themselves, so to the extent that you, let’s say, generate more credit than you actually have in liability, then they are general business credits. So they carry back one year and forward for up to 20. So note, that sounds great, you know, in theory, but on paper, we want to make sure that we’re actually generating credits that can be used, or at least we understand that you would be able to use them for the foreseeable future. Not so far out that

you know, does this even make sense? So we like to, definitely thorough in ensuring there’s utilization of those credits.

Chris (26:04.54)
Okay, no, that makes sense because I know, you know, we’ve had clients that have done, you know, whatever types of incentives that they can’t take, you know, because they’re not, they may not be profitable. And so to your point, then they just kind of sit there for a while. now can this, can this, you kind of what we talked about with COSA, can this be used in conjunction with other incentives? I mean, is there

Carrie Gibson (26:31.324)
yeah, absolutely. I we want to, we’re always going to look and ensure there’s definitely different roles of interplay between them. We’re, very aware and familiar with those, but yes, I mean, we have clients that we’re helping with R and D credits. We’ve done a cost like study on their building. We’re looking at one 70 90 for them and we do work opportunity tax credits. So you can, you can certainly do all of these things.

Chris (26:54.066)
Okay, perfect. Perfect. Well, what what did I miss on these credits on the R &D credits? Is there anything that else

Carrie Gibson (27:01.708)
I mean, the one thing I’d share is just the potential value so people know what it could actually look like. So the credits roughly, I’d say anywhere from 8 to 10 % of qualified expenses. So that would be your below the line net credit. And again, the expenses that we look to are, like I mentioned, the payroll, any outside contractors that you may leverage, supply costs.

and then potentially cloud computing expenses, which typically lends itself more to the software and tech industry. But we look at the expenses in those areas, ultimately carve out what’s qualified versus not. And of your qualified expenses, the credit is roughly between 8 to 10%. Back to the back end. But yes, just want to make sure we shared the value.

Chris (27:46.697)
Okay.

Chris (27:52.202)
Yeah, no, absolutely, absolutely. And with that being a dollar for dollar, it’s even those 10%, it’s valuable, right? Because it’s really, if it’s above the line, that 10 % equates to a much higher number.

Carrie Gibson (28:02.005)
Nah.

Carrie Gibson (28:07.478)
Sure, and it’s something that folks typically work into their overall tax strategy and claim annually. It’s a permanent credit, so it is something that you can claim every year on your tax return.

Chris (28:20.518)
Okay, perfect. No, that’s great. Well, I definitely appreciate you guys joining us today. So, so someone needs to get in touch with you guys. They have a R &D credit, Watsy credit, whatever it may be, a cost tag. How do they reach

Carrie Gibson (28:30.868)
Yeah. Yeah.

Carrie Gibson (28:36.256)
Well, I will, I can share my email at cgibson at c -t -i -l -l -c dot com. And I can make sure to get you connected with all the right folks internally here.

Chris (28:47.688)
Perfect, well appreciate it. And I will say, as I mentioned, we’ve worked with you guys for a lot of years with Work Opportunity Tax credits and all different kinds of credits. So you guys do a great job. And again, I do appreciate you joining us today.

Carrie Gibson (29:02.774)
Thank you, thanks for having us.

Chris (29:04.542)
Thank

Bill Mark (29:04.606)
Thank you.