Cost segregation studies can be one of the most advantageous tax strategies available to dealers who own property. Accelerating depreciation deductions lowers taxable income and taxes due. The auto dealership industry is prime for accelerating tax deductions and generating cash flow through cost segregation studies. From specialty equipment in service areas to required image enhancements and renovations, accelerated deductions are hidden within your auto dealership facility.
“With the amazing year dealers are having, coupled with a stellar year last year, dealers are acquiring and upgrading their stores with a remodel or even constructing a new one. It’s important to componentize newly acquired building assets immediately after purchase or after construction with a cost segregation study.”
-Matt Fitzpatrick, CPA, Manager
The primary goal of a cost segregation study is to identify all property-related costs that can be depreciated over 5, 7 or 15 years. Cost segregation studies can also identify qualified improvement property (QIP), which qualifies for a 100% bonus. The resulting componentization of building assets makes future partial dispositions of longer life assets easily recognizable.
On average, auto dealerships utilizing a cost segregation study will find that 10-15% of the basis is reclassified to a five or seven-year recovery period. An additional 10-15% is reclassified to a 15-year recovery period, as opposed to the longer recovery periods when no cost segregation study is utilized. By accelerating 25-30% of the depreciation deductions—along with applying bonus depreciation and/or Section 179 expenses to qualifying property, current tax, and resulting cash—savings can be substantial.
A cost segregation study examines components classified as part of a building through an IRS approval process. This helps taxpayers accelerate depreciation deductions, reducing taxes paid and resulting in increased cash flow.
Most likely, any newly acquired dealership will undergo renovations. When you have a cost segregation study done at the time of purchase, you’ve simultaneously identified the accelerated property and the property with longer depreciable life. You can then utilize partial dispositions to recognize the property if it is demolished or disposed of after renovations. Partial dispositions can only be identified in the year they occur.
There are several reasons why dealerships are great candidates for cost segregation studies.
In many instances, decorative facades and other signage items are installed as part of a brand image enhancement program. These items, depending on how they're installed, could potentially be reclassified to a shorter recovery period, which would significantly increase the amount of basis accelerated to a shorter depreciation period. Facility renovations are typically more beneficial from a cost segregation perspective since most of the cost incurred relates to reconfiguration or decor modifications as opposed to structural enhancements.
Retail Motor Fuels Outlet Classification
Similar to auto dealerships, gas stations and other retail motor fuel distributors and sellers may also qualify for a 15-year recovery period. This allows entire structures to receive the beneficial 15-year recovery period as opposed to the standard 39-year timeframe.
Qualified Improvement Property
Another aspect of renovations where benefit may be lurking is within qualified improvement property. Qualified improvement property is any interior non-structural improvement made to a previously placed in service non-residential building. In addition to the interior improvements, the Tax Cuts & Jobs Act also added roofs, HVAC, security systems and fire suppression systems to the definition of qualified improvement property.
Currently, qualified improvement property has a recovery period of 39 years, but the Tax Cuts & Jobs Act intended to assign a 15-year recovery period to qualified improvement property. Barring a technical correction of the tax law, this will remain the case. However, there is still benefit to qualified improvement property, as the Tax Cuts & Jobs Act did change the Section 179 deduction to include qualified improvement property (subject to the limitations).
Floor Plan Financing and Bonus Depreciation
Within the dealership industry, some properties may be disqualified from bonus depreciation because of floor plan financing indebtedness. If the property has taken the floor plan financing indebtedness into account under the new rules for limiting the business interest deduction to 30%, then the property would not qualify for bonus depreciation. However, a real estate entity and operating entity should be treated as separate properties. In this case, if the operating entity is carrying the floor plan financing indebtedness, we believe the real estate entity should still be eligible to claim bonus depreciation.
A cost segregation benefit analysis was recently conducted for a group of eight auto dealerships. The parent company had acquired buildings, new construction and renovation projects, which resulted in a first-year savings of over $2,000,000 once the study was complete.
If you are renovating or remodeling your dealership, have your tax advisor look at your depreciation schedule to capture all the depreciation expenses you’re entitled to. Whether newly constructed, purchased or renovated, the components of your building should be properly classified through a cost segregation study into shorter recovery periods for computing depreciation.
Cost segregation can be one of the most advantageous tax strategies available to property owners. Accelerating depreciation deductions leads to lowering of taxable income and taxes due. IRS rules allow taxpayers to apply a cost segregation study any time after the building is purchased, renovated or constructed, which provides a unique opportunity to plan which tax year depreciation deductions are realized.
Cost segregation can help you increase cash flow and reduce tax liability.