How Dealers Can Benefit from Cost Segregation Studies

Architects working together

Key Takeaways

  • A cost segregation study examines and potentially reclassifies building components to accelerate depreciation deductions and increase cash flow.
  • Cost segregation studies can still be used to identify opportunities for bonus depreciation, which is being phased out through 2027.
  • After a cost segregation study, we find on average dealerships reclassify 20-30% of the property’s basis.

Completing a cost segregation study to identify accelerated depreciation deductions may be an advantageous tax strategy for dealers who own property.

The auto dealership industry is prime for accelerating tax deductions and generating cash flow through cost segregation studies. From specialty equipment in vehicle service areas to required image enhancements and renovations, accelerated deductions may be hidden within auto dealership facilities.

“Dealers are continually 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, Senior Manager | Eide Bailly

The Impact of a Cost Segregation Study

The primary goal of a cost segregation study is to identify real property related costs, generally depreciated over 39 or 27.5 years, and reclassify the recovery period to five, seven, or 15 years. Cost segregation studies can also identify qualified improvement property (QIP), which qualifies for bonus and Section 179 depreciation deductions. The resulting componentization of building assets makes future partial dispositions of longer life assets easily recognizable.

The Tax Cuts & Jobs Act phases out bonus depreciation after 2022. Here are the bonus depreciation deduction percentages each year during the phase out*:

2023 = 80%
2024 = 60%
2025 = 40%
2026 = 20%
2027 = 0%

*Long Period Production Property allows for 100% bonus through 2023 and then begins to decline by 20% every year after. To qualify, the property must take longer than one year to build and be over $1 million in spend, or take two years to build.

After a cost segregation study, we find on average auto dealerships reclassify 10-15% of the property’s basis to a five or seven-year recovery period and an additional 10-15% to a 15-year recovery period.

By accelerating 20-30% 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.

What Is a Cost Segregation Study?

A cost segregation study examines components classified as part of a building through an IRS outlined process. This helps taxpayers accelerate depreciation deductions, reducing taxes paid and resulting in increased cash flow.

Newly acquired dealerships will generally undergo renovations. Completing a cost segregation study allows the buyer to simultaneously identify accelerated property and property with longer depreciable lives. Once identified, partial dispositions can be used to recognize deductions of demolished or disposed property from the renovations. Additionally, demolition costs may be expensed. Partial dispositions can only be identified in the year they occur.

Cost Segregation Studies Are an Ideal Fit for Dealerships

There are several reasons why dealerships are great candidates for cost segregation studies.

Image Enhancements

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

Like auto dealerships, gas stations, car washes, and other retail motor fuel distributors and sellers may 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. Qualified improvement property has a 15-year recovery period.

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 can still be eligible to claim bonus depreciation.

Cost Segregation in Auto Dealerships: A Significant Savings

A cost segregation benefit analysis was recently conducted for a group of eight auto dealerships. The parent company had acquired buildings and new construction and renovation projects, which resulted in a first-year savings of over $2,000,000 once the study was complete.

Cost Segregation as a Tax-Saving Opportunity for Your Auto Dealership

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, without amending, after the building is purchased, renovated, or constructed, which provides a unique opportunity to plan which tax year depreciation deductions are realized.

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