Author: Ted Williams
Do you have a ‘Tax Preparer’ or a CPA?
Depending on your answer, you could be getting bad advice which puts more money in the IRS’s coffers (and leaves less in your pocket).
Below is the crux of a typical tax preparer’s opinion regarding Engineering Based Cost Segregation Studies which an experienced CPA would say has kept many commercial property owners from implementing this highly beneficial tax strategy which is effectively encouraged by the IRS.
Here is a typical ‘tax preparer’ statement to commercial property owners:
“You are not getting additional depreciation, you are accelerating depreciation by allocating cost to shorter life. I advise against such a strategy as there can be future tax implications and also there is upfront cost involved.”
For frame of reference, here is the IRS’ view (from www.irs.gov) on cost segregation:
“Buildings and structural components have substantially longer depreciable lives than personal property. Therefore, it is desirable for taxpayers to maximize personal property costs in order to accelerate depreciation deductions and, hence, reduce tax liability.” (source)
Here’s how many experienced CPAs would look at this matter:
The above point of view isn’t considering the bigger picture. For instance, only looking at the (potentially) negative capital gains tax implications associated with cost segregation by itself is ‘missing the forest for the trees’:
- It is not necessarily true this would be a ‘negative’ as it would depend on the ultimate sale price versus the depreciable cost basis; if the sale price is equal to or less than the depreciable cost basis then the capital gains issue is, well, a non-issue.
- There is no consideration given to the positive effect on the income tax picture due to cost segregation; this positive effect needs to be weighed against the potentially negative capital gains effect.
- In general, property owners will benefit from cost segregation if they hold the building for at least 18 months. One reason for this dynamic is that the capital gains tax, even at the 25% ‘re-cap’ rate, is much lower than the typical 35% to 39.6% income tax rate.
- There is an assumption that the property owner is absolutely giving up all future depreciation benefits in exchange for taking those benefits now. Well, if the owner never replaces carpeting, wiring, plumbing and other such non-structural components, then, ‘yes’, that would be the case. But the reality is that these components will ultimately be replaced (which is the basis for the relatively shorter/accelerated tax-compliant depreciation time-lines for such items). The associated replacement costs can be depreciated.
So, in fact, the depreciation isn’t lost in reality. Plus, only about 20% of the building can be ‘accelerated’…the remainder stays in 39-year S/L.
- In effect, this is a time-value-of-money/opportunity cost ‘play’. So an owner’s capitalization rate needs to be considered; a critical mass of money in the hands of a good businessperson NOW could feasibly produce a 10% or greater return. An owner’s ability to convert that ‘now cash’ (i.e., cash that becomes available due to cost segregation’s resulting reduction in current income tax) into more cash could easily dwarf the down-the-road bit-by-bit depreciation cost deductions which the owner MAY be passing on.
- The “upfront costs” for conducting an Engineering Based Cost Segregation Study are barely worthy of factoring into the benefits equation; first, the Study is a business expense and effectively comes at a 35% (+/-) ‘discount’, and secondly, the Study cost can often be less than 10% of the tax benefit (even without the ‘discount’). Most business-minded people would find a project with a minimum 10:1 benefit-to-cost ratio to be worthy of pursuit.
So, do you have a ‘Tax Preparer’ or a CPA? The best way to find out is to ask him or her how they perceive the value of an Engineering Based Cost Segregation Study for a commercial property owner.
To stream a 3-minute video regarding this topic, please click here.
For additional information contact us.
Specialized Tax Incentives for the Funeral Home Industry
The IRS Is Trying To Help Funeral Homes Pay Them Less! (Don’t believe it? – read on)
This statement is directly from www.irs.gov, “Buildings and structural components have substantially longer depreciable lives than personal property. Therefore, it is desirable for taxpayers to maximize personal property costs in order to accelerate depreciation deductions and, hence, reduce tax liability.”
This largely overlooked tax strategy often reaps over $100,000 in tax benefits for a typical funeral home.
This strategy dates back to 1959 when the U.S. Tax Court allowed building owners to pursue component-based depreciation. In 2004 the IRS established a ‘Cost Segregation Audit Techniques Guide’; the Guide provides clear direction regarding how to establish the cost basis for non-structural building components and which depreciation time-lines to use for electrical wiring, plumbing, partitions, carpeting, finishes, parking lots, landscaping (and other qualifying components).
Think of it this way; why depreciate, say, carpeting in a 39-year time-line as if it were a structural steel beam? The IRS allows building owners to depreciate many such items in a more appropriate 5-year time-line. In fact, roughly 20% of your Funeral Home could likely be moved from 39-year to 5-year time-lines!
And just when you think you’ve died and gone to heaven (a little Funeral Home industry humor), it gets better! The IRS allows you to move such depreciation that you didn’t claim in years past, so-called ‘catch-up depreciation’, into your current tax year without having to do an amendment. Your CPA can move this ‘catch-up’ figure to your current tax year through a simple 481 change in accounting method.
The IRS recommends that building owners wishing to take advantage of this logical and well-established tax strategy conduct an Engineering Based Cost Segregation Study which documents:
- A building’s qualifying non-structural components and
- The depreciable cost basis for each of those components
The Study also places each component in the appropriate time-line per the IRS Guide.
For additional information contact us.
Auto Dealerships See Tax Benefits From Renovation
Many automobile dealerships implement significant renovations as the industry morphs due to technology changes and as manufacturers rebrand. The goal of the renovations are, of course, to improve top line performance (sales).
Top line goals can effectively be achieved more quickly by capitalizing on the tax benefits associated with the renovations; for instance, it’s not uncommon for $1MM in renovations to conservatively equate to a $60,000 tax related improvement in the bottom line. Given a 10% profit margin, that equates to a $600,000 increase in top line results.
What Tax Benefits?
Tax benefits associated with construction costs can be procured through an Engineering Based Cost Segregation Study. This Study applies tax compliant depreciation time-lines to certain non-structural components. For instance, instead of depreciating carpeting over 39 years as if it were a structural item, it would be depreciated in five years. Many other non-structural building components can be depreciated in 5, 7 and 15 years versus 39 years.
Furthermore, the tax benefits of properly depreciating current renovations can apply to the entire existing facility, including past renovations (see “The #1 Lie About Cost Segregation“).
So, here are the benefits of reducing Federal and State taxable income by safely ‘accelerating’ depreciation on certain building components with a rigorous Study:
- New renovation, purchase or construction will result in increased cash flow in the first 6 years.
- Owned for 5 or more years qualifies for all unrealized depreciation carried forward into the current tax year.
From our experience, its not uncommon to document as much as $200,000 in accelerated depreciation per $1MM worth of building; assuming a 35% tax rate, the resultant reduction in taxable income would translate to a $70,000 bottom line improvement.
A project fee for a Study is typically between $10,000 and $20,000 per building, and can depend on property size, construction quality, location, availability of accurate construction documents, other.
So, a $2MM building could provide a $140,000 bottom line improvement; that’s about a 10:1 benefit-to-cost ratio for performing the Study (…and that’s not considering the net cost basis of the Study after writing it off as a business expense!).
In summary, cost segregation analysis is a logical tax strategy dating back to 1959 when the Tax Court first allowed component-based depreciation of buildings (though greatly clarified over the past decade with the IRS’s Audit And Technique Guidelines). Even properties purchased years ago can capture benefit with a very attractive cost-to-benefit ratio for performing an Engineering Based Cost Segregation Study. Any auto dealership whether purchased, constructed or renovated for costs in excess of $500,000 should consider this service.
To stream a 3-minute video regarding this topic, please click here.
For A/E/C Companies, Finding New Profit Centers is a Must
“Profit Center”, it’s the new buzzword being tossed around like a football across corporate America. It sure sounds good, doesn’t it? Of course it does, who doesn’t like profits? Unfortunately saying the words “Profit Center” and actually having one are two different ball games.
To put it simply, a Profit Center is defined as, “The branch or division of a company that creates profits individually and separately from the main organization.”
There are essentially two methods of creating a profit center for your organization. First, you can offer a new service that creates a profitable revenue stream. Second, a cost center can turn into a profit center by selling those administrative “cost of doing business” services to other firms. As Management Professor William E. Halal so eloquently stated to USA Today Magazine, “When a business firm becomes a corporate community of entrepreneurs who buy, sell and launch new products and services internally as well as externally, it gains the same creative interplay that makes market economies so advantageous.”
For the purpose of this article we will focus on creating a new profit center rather than converting a cost center into a profit center. The easiest way to create a new profit center is to add service offerings that align with an existing client base.
For example, CPAs, A/E/C firms, and even most Contractors have an existing base of business clients and referral partners who own commercial property. Are they maximizing on the plethora of accumulated property data, let alone the hard-earned relationships they’ve developed? These are not cold leads or warm contacts but EXISTING CLIENTS who have already paid money for their services. Failing to monetize an existing client base with value-added services is just bad business.
So, how do I create a new service offering and market it to my existing client base? The easiest way to accomplish this is to partner with an organization that already has a profitable service on the market that would be a benefit to your clients. Once a partnership is established, the next step is to effectively spread the word to your existing client base. Communicate how your new opportunities will benefit them and move them through the sales cycle. If you have done it right, your existing clients will thank you for your high level of client service. This truly becomes a “win-win-win” proposition!
Growth Management Group, LLC (GMG) provides custom services to business owners across the nation to increase sales, reduce cost, and procure specialized tax incentives. GMG also offers strategic partnership to firms looking to utilize their existing client relationships to generate new revenue streams.
For additional information contact: Growth Management Group, LLC (888) 705-5557, www.gmgsavings.com.