If you’ve purchased, built or substantially remodeled your restaurant within the last few years, you’ve probably heard the term “Cost Segregation”. If you haven’t, you may be paying your taxes earlier than necessary. If you have heard of it, you most likely know that the reason to have a cost segregation study performed on your building is to increase cash flow by accelerating tax depreciation deductions into the earlier years of the life of the building, and thus reduce tax payments during those years.
Depreciation of Property
The normal tax depreciation life of a restaurant building is 39 years (15 years in certain situations), while the normal tax depreciation life of equipment and non-structural components of a building are between 5 and 15 years. Typically, when you purchase a building you make an allocation of the total cost between the building and the land. In many cases this is where the analysis ends. A cost segregation study is a way to accurately determine the cost of the building components that may qualify for a shorter depreciable life.
For new construction there is generally more information available to determine the cost of building components, such as a contractor’s invoice. However, the classifications used by the contractor are usually too broad, and the classifications may not be supportable in the eyes of the IRS. A cost segregation study using the engineering valuation approach provides a methodology that typically yields the highest benefit and supportability with the IRS.
Example of Possible Savings
Let’s assume you purchased or built a building for $1million exclusive of land costs. Rather than treating that entire cost as related to the building (depreciable over 39 years), let’s further assume that a cost segregation study identifies 30% of that cost as being related to non-structural components of the building (depreciable over 5, 7 and 15 years). Assuming a 35% tax rate, the first year tax savings would be roughly $40,000. Over the first six years it would be roughly $80,000, and the net present value of the tax savings over the life of the building would be roughly $50,000.
Is a Cost Segregation Study Right for You?
In order to justify the expense of a cost segregation study, it should be determined whether or not the extra depreciation deduction will result in a short term reduction of your tax liability.
Most providers of this service will give you a free estimate of the benefit, which is normally several times the cost of performing the study. So if you have built, remodeled or purchased a building within the last ten years it may be a good time to take another look.
