What a Cost Segregation Study Would Do for the Aladdin's 40 Investors

A hypothetical, built on public numbers. Last week on the Baldwin Appraisal Services blog I pulled apart the capital stack behind Zach Molzer's $38 million conversion of the Aladdin Hotel in Kansas City. This is the follow-up question that a cost segregation guy cannot help asking: now that the building is open, what does the depreciation look like, and what does it do for the people who wrote the equity checks?

If you are coming to this article without the first one: Baldwin Appraisal Services is the commercial real estate appraisal practice I run alongside National Cost Segregation. The first article lives on that blog. You do not need to have read it to follow this one — everything you need is in the paragraph above.

None of what follows is Molzer's actual tax position. I do not have his cost certification, his partnership agreement, his historic tax credit structure, or his investors' tax returns. What I have is the public record I laid out in the first article: a $2.5 million purchase in June 2024, roughly $35.5 million of rehabilitation, 122 apartments, a rooftop bar, federal and Missouri historic tax credits, and an equity vehicle called KC Aladdin LP that raised $5.615 million from 40 investors. Everything below is a worked example on those numbers, and every assumption is labeled. Treat it as a way to understand how this works on a real building, not as advice about that building.

The thing that makes this deal different

Most cost segregation articles start with "a building is not one asset, it is hundreds." True, and I will get there. But the Aladdin has a wrinkle that most of the buildings I study do not: it is a historic tax credit project, and the credit and the depreciation are fighting over the same dollars.

Here is the mechanism. The federal rehabilitation credit is 20 percent of qualified rehabilitation expenditures, and Missouri adds a 25 percent state credit on top. Qualified expenditures are, by definition, spending on the building itself — depreciable real property with a long class life. Tangible personal property is not a qualified expenditure. Appliances, bar equipment, furniture in the amenity spaces, decorative light fixtures, window treatments, data cabling, security systems, and the electrical runs that exist only to serve that equipment are not part of the building for credit purposes, no matter what the general contractor's pay application calls them.

That is exactly the set of assets a cost segregation study identifies. So on a historic credit deal the study is not a pure add. Every dollar it moves into five-year property is a dollar that comes out of the credit base. The question is not "should we do cost seg," it is "what is this dollar worth as a credit versus what is it worth as an immediate deduction," and the answer depends on which dollar you are looking at.

For clearly personal property the answer is easy. A commercial ice machine in a rooftop bar was never a qualified rehabilitation expenditure. Claiming the credit on it is an overclaim, and the Park Service and the IRS both look. The study puts it where it belongs and it gets bonus depreciation. There is no tradeoff, only compliance plus benefit.

For the gray items — and there are a lot of them in an apartment conversion — the math cuts the other way. Take one dollar of kitchen cabinetry, which many cost segregation practitioners treat as five-year property and many historic credit preparers treat as part of the building. As a qualified expenditure it earns 20 cents of federal credit, 25 cents of Missouri credit that sells for something like 22 cents cash, and the remaining basis still depreciates over 27.5 years. As five-year property it earns a deduction worth about 37 cents at the top federal rate, once, and nothing else. On a present value basis the credit route wins, comfortably. A sponsor on a credit deal will and should leave the gray items in the building. The study still has to classify them consistently, because the IRS will not let you call a cabinet a structural component for the credit and personal property for depreciation in the same year.

So on this building the study is doing two jobs. It is finding the clearly personal property that has to come out of the credit base anyway, and it is documenting the classification of everything else so that the credit and the depreciation schedule tell the same story. That second job is the one that matters in an audit.

The dates matter more than usual

One more wrinkle before the numbers — and it is one I have not seen anyone write about.

The 2025 tax law made 100 percent bonus depreciation permanent for property acquired after January 19, 2025. Property acquired before that date, even if it is placed in service in 2026, falls under the old phase-down and gets 20 percent bonus this year. For a building you construct or rehabilitate yourself, the acquisition date is when physical work of a significant nature begins, and the safe harbor says you are on the old schedule if more than 10 percent of total construction costs were incurred before January 20, 2025.

Now look at the Aladdin's timeline. Molzer bought the building in June 2024. Interior demolition started in December 2024. The wallbreaking ceremony with the mayor was January 22, 2025. Full building permits came in March 2025.

The $2.5 million purchase is pre-cutoff, and any personal property in that purchase basis gets the 20 percent rate. On a hotel that had been closed since March 2020 and was gutted to the shell, that is a rounding error. The rehabilitation is the real question, and one month of interior demo on a $35.5 million job is nowhere near the 10 percent threshold. The rehab should qualify for full bonus. But "should" is doing work in that sentence. The sponsor's CPA needs a cost ledger that shows what was spent before January 20, 2025, and the study needs to reference it. Three days between the cutoff and the wallbreaking is the kind of detail that sits quietly in a file until an examiner asks about it.

The hypothetical schedule

Here are my assumptions, in one place. Total cost $38 million. Land $1 million of the $2.5 million purchase — a guess at a downtown footprint under a shell that was worth roughly nothing. On a real engagement, this number should not be a guess. A formal cost allocation appraisal from a Certified General Appraiser establishes the land value in a format that stands up to scrutiny; on a deal this size, where the land/building split affects both the credit base and the depreciation schedule, that document belongs in the file. Rehabilitation $35.5 million. Placed in service August 2026, when the first residents moved in, which puts the building under the mid-month convention with four and a half months of depreciation this year.

For a historic hotel-to-apartment conversion, I would expect a study to find clearly personal five-year property at about 12 percent of the rehab cost. That is lower than the 20 to 30 percent you see quoted for garden apartments, and it is lower on purpose: there is no parking lot, no site work to speak of, and I am leaving the gray items in the building because the credit is worth more on them. Fifteen-year land improvements on a 16-story downtown high-rise are almost nothing; call it half a percent for the rooftop terrace hardscape, exterior lighting, and signage.

On those assumptions:

Five-year property: ~$4.26 million. Fifteen-year property: ~$180,000. Both get 100 percent bonus in 2026 — that is roughly $4.45 million of first-year deductions before the building itself is touched.

Qualified rehabilitation expenditures are the $35.5 million less the $4.45 million of personal property and land improvements, or about $31.1 million. The federal credit at 20 percent is about $6.2 million. The Missouri credit at 25 percent is about $7.8 million. These are in the neighborhood of the $12–$15 million I estimated in the first article, refined by actually taking the personal property out.

The federal credit reduces the building's depreciable basis dollar for dollar. So the 27.5-year building basis is $37 million of depreciable cost, less $4.45 million of reclassified property, less $6.2 million of federal credit, or about $26.4 million. The Missouri credit does not reduce federal basis, though the proceeds from selling it are taxable income to whoever sells it.

Why 27.5 years and not 39? Because a building qualifies as residential rental property if 80 percent or more of its gross rental income comes from dwelling units. The Aladdin's 122 apartments at roughly $1,500 a month gross about $2.2 million a year, and a rooftop bar lease would have to exceed $550,000 a year to break the test. It will not. The whole building is residential for depreciation purposes, bar included.

First-year depreciation on the building is $26.4 million over 27.5 years, prorated for four and a half months, or about $360,000. Add the bonus and the total 2026 depreciation deduction in this hypothetical is about $4.8 million.

For comparison, if the sponsor did nothing, treated every dollar as building, and claimed the credit on all of it, the first-year deduction would be about $410,000 — and the credit would be overclaimed by roughly $900,000 federal and $1.1 million Missouri on property that was never eligible. That is not a comparison of two legitimate choices. It is a comparison of doing it right and doing it wrong, and the study is how you do it right.

What that means for one investor

KC Aladdin LP raised $5.615 million from 40 investors, which is about $140,000 each. Assume the limited partners are allocated 90 percent of depreciation, with the rest going to the general partner — a common structure and not necessarily this one. Assume also that the depreciation sits in the same entity as the equity, which is true unless the historic credit was syndicated to a separate investor through a master lease, in which case the credit goes one way and the depreciation stays with the landlord partnership. I do not know which structure Molzer and Free Heel used.

On those assumptions, a $140,000 investor is allocated roughly $100,000 of first-year loss from bonus depreciation. That is 71 cents of deduction for every dollar invested, in the first year the building is open.

Whether that is worth anything depends entirely on who the investor is. For most limited partners the loss is passive, and a passive loss can only offset passive income. An investor with no other passive income carries the loss forward until the partnership sells or until they have passive income to absorb it. For that investor the study changes the timing of nothing in year one, and the benefit shows up at exit, where the suspended loss is released and largely offsets the recapture on the same assets. Real, but modest.

For an investor who does have passive income, or who qualifies as a real estate professional and materially participates, or who is a developer with other buildings throwing off taxable cash flow, the loss is usable now. At a combined 40 percent federal and state rate, $100,000 of deduction is $40,000 of tax not paid in April 2027, on a $140,000 investment made in 2025. That is 29 percent of the equity back in the second year, before the building has paid a distribution.

A simple illustration to put that in return terms: take an investor who puts in $140,000 in mid-2025, receives nothing during construction, gets a 5 percent cash yield growing 3 percent a year from 2027, and exits at the end of 2031 at 1.5 times equity. Pre-tax, that is about a 10.5 percent IRR. After tax with no study, paying capital gains at exit: about 9.2 percent. With the study, for an investor who can use the loss: about 11.1 percent. For an investor whose loss is suspended until the sale: about 9.5 percent.

The honest range is somewhere between 25 and 190 basis points of after-tax return, and the whole spread is explained by the investor's own tax situation, not the building. That is the sentence I wish every cost segregation marketing page would print. The building creates the deduction. The investor's return determines whether the deduction is worth anything this decade.

Three things I would tell the sponsor

First, the study is cheap insurance on a deal this complicated. The historic credit is going to get reviewed. The bonus depreciation acquisition date is going to sit in the file. The 80 percent residential test needs a rent roll behind it. A study done by someone who walked the building and can defend every line is the document that answers all three questions at once, and on a $38 million project it costs less than one month of the rooftop bar's liquor order.

Second, do not let anyone sell you a study that promises 25 or 30 percent five-year property on a historic credit deal. That number is possible on a suburban garden complex with a parking lot and a pool. On the Aladdin it would mean either pulling gray items out of the credit base where they are worth more, or classifying things aggressively enough that the credit reviewer and the depreciation schedule disagree. Twelve percent that survives is better than twenty-five percent that does not.

Third, if the land allocation matters to your deal — and on any acquisition over a few million dollars it does — get it documented before you file, not after. The cost segregation study establishes the five-year and fifteen-year buckets. A separate appraisal from a Certified General Appraiser establishes the land value. Both documents answer different questions, and an examiner who is already looking at the historic credit and the bonus depreciation will ask about both. You want both answers in the file.

I said in the first article that the Aladdin is a project that works because of the tax credits and the abatement, not on the real estate alone. The depreciation is the third leg of that, and for the right investor it is not a small one. For the wrong investor it is a line on a K-1 that means nothing until 2031. A good study will tell you which kind of investor you are before you write the check, not after.

*Mike Baldwin is a Certified General Real Estate Appraiser at Baldwin Appraisal Services and the founder of National Cost Segregation. Every study includes a live on-site inspection by a licensed appraiser. He has not inspected the Aladdin, has no relationship with Molzer Development or its investors, and would be happy to walk the building if asked. Nothing in this article is tax advice; talk to your CPA about your own return.*

Sources and assumptions

Assumptions that are mine and not from any source: $1 million land allocation; 12 percent five-year and 0.5 percent fifteen-year property; Missouri credits sold at roughly 90 cents; 90 percent of depreciation allocated to limited partners; 40 percent combined marginal rate; 37 percent ordinary rate on recapture; 23.8 percent on capital gain at exit; the cash flow and exit assumptions in the return illustration. Change any of them and the numbers move.

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