Cost Segregation Analysis: Don’t Overpay in Taxes This Year

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Many restaurateurs are unaware of a tax tool that could save them thousands of dollars on their taxes. Cost segregation analysis is a tax strategy restaurateurs can use to reduce their tax liabilities by identifying hidden tax deductions that result in thousands of dollars in tax savings.  Because cost segregation isn’t commonly utilized by CPAs, many restaurant owners end up overpaying in taxes. 

Cost segregation breaks out certain non-structural components of a restaurant building and allocates shorter life classes to those components depreciating them at an accelerated rate.  This means more tax deductions are available in the earlier years of a restaurant.

How does it work?

For tax purposes, the standard class life for most non-residential buildings is 39 years. However, certain non-structural elements of a building, such as most land improvements, dedicated electrical & plumbing work related to restaurant equipment, certain decorative features and elements considered accessories to the operation of the building may qualify for shorter class lives.

For some restaurants, as much as 50 percent of building components can be reduced to five-, seven- and 15-year class lives, which significantly increase a restaurant’s overall tax deductions.

Cost segregation analysis can be performed on real estate put into service as far back as 1987.  Tax laws even allow a restaurant owner to go back in time and deduct any depreciation benefits that were missed in prior years, without the need to amend prior year tax returns.

If a restaurateur has constructed, purchased, expanded or remodeled a restaurant, cost segregation analysis can be used to depreciate certain types of property and land improvements over a much shorter period.

What are the qualifications?

All types of restaurant facilities may qualify for a cost segregation analysis, including quick-service, casual and fine dining, even if a restaurateur does not own the building where the restaurant is located.

Restaurants placed into service after 1986 that were constructed or acquired by the current owner are eligible for a cost segregation analysis.  Free-standing buildings and build-outs that are part of a multi-tenant space, including malls or strip centers, are all eligible for cost segregation studies.

The non-structural building components (personal property) that qualify for accelerated depreciation include, but are not limited to:

  • Dedicated plumbing, electrical and gas lines to kitchen & bar equipment
  • Equipment hood fire detection/suppression systems
  • Grease traps/tanks
  • Walk-in coolers/freezers and related dedicated electrical and plumbing
  • Cabinetry
  • Counters
  • Decorative millwork
  • Decorative lighting and related dedicated electrical work
  • Certain floor and wall coverings

Land improvements that qualify for accelerated depreciation include, but are not limited to:

  • Certain excavation work
  • Storm water systems
  • Parking lot lighting and related dedicated electrical
  • Paving, curbs and sidewalks
  • Dumpster enclosures
  • Landscaping and irrigation systems

Who can perform a cost segregation analysis?

The Internal Revenue Service recommends using a third party for all cost segregation studies.  Restaurateurs should work with someone who specializes in cost segregation, rather than just a standard CPA.

A cost segregation specialist should have engineering expertise that will enable them to identify the various components within a restaurant facility that qualify for accelerated depreciation.

The specialists should also be (or work with) a CPA who is not only an expert in tax law related to cost segregation, but who is also capable of determining whether a restaurateur qualifies for a cost segregation based on their specific tax situation.

The Process

  1. Initial Consultation: A restaurateur should talk to a cost segregation specialist to determine if the restaurant can benefit from a cost segregation study.  The consultation should include a projection of tax benefits for the specific restaurant facility.  This projection should then be used by the cost segregation specialist or the restaurateur’s CPA in verifying the restaurateur qualifies for a cost segregation study based on his or her specific tax situation.
  2. Property Analysis: A property analysis requires a cost segregation specialist to review blueprints, if available, and conduct an on-site inspection to identify components of the property that are subject to accelerated depreciation.  A properly documented cost segregation study should include photographs of property components eligible for accelerated depreciation.
  3. Identification of Component Costs:  A cost segregation specialist will usually use either an actual cost or engineered cost approach to identify cost detail related to all the component costs of the restaurant property.  The engineered cost approach is a cost estimating approach accepted by the IRS that provides the most specific cost detail and most often the greatest tax benefit. The detail gathered from either approach will then be categorized into the proper property classes for tax purposes.
  4. Cost Segregation Analysis: During this stage, a cost segregation specialist will produce a formal written report for a restaurant owner’s records.  These records, along with supplementary instructions from the cost segregation specialist, should be provided to a CPA so they can incorporate the cost segregation analysis into the current year’s tax return.

The goal of cost segregation analysis is to identify the maximum amount of tax deductions while adhering to the limits of the IRS.

Whether it’s fast food or fine dining, a cost segregation study is a valuable tool for every restaurant concept because it can reduce tax burdens, resulting in increased cash flow for further growth, investment or operational needs.

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