Cost Segregation & Grocery Stores: A Perfect Fit

February 2017 | Article

Many businesses are reaping the tax benefits of a cost segregation study, and grocery stores are prime candidates for the IRS-approved process. Eide Bailly has provided cost segregation studies to a variety of grocery store owners, which has allowed us to identify a few questions that grocers commonly ask. They include:

  • What is a cost segregation study?
  • How is it done?
  • For whom does it work best?
  • What are the benefits and how much does it cost?
  • What are some planning ideas?
  • How does a study work with the new repair regulations?

Let’s take a look at some of the answers to these questions.

What Is a Cost Segregation Study?
A cost segregation study is an IRS-approved process (assuming the study is done following acceptable standards) that allows you to segregate the building components of your grocery store into shorter depreciable recovery periods. The result is a significant acceleration of your depreciation deductions resulting in a lower income tax bill and an increase in current cash flow.

How Is It Done?
A quality study should result in all of the building components being broken down and assigned to an appropriate depreciable recovery period. For a grocery store, those recovery periods generally are:

  • 5-Year: Examples of items potentially classified as a 5-year assets include vinyl flooring; the electrical cost directly related to operating coolers, refrigeration equipment, and display lighting; plumbing cost connected to the coolers and refrigeration equipment; signage; shelving; and other equipment.
  • 15-Year: Examples include the parking lot pavement, landscaping, and sidewalks.
  • 39-Year: Examples include structural components such as the roof, concrete floors, HVAC to heat and cool the grocery store, and walls.

The process completed in performing a cost segregation study includes:

  • A site visit to determine if the building plans are accurate, identify those items that can be moved into the 5-year and 15-year “buckets,” and document the property through pictures and narrative video in case the study is ever looked at by a third-party.
  • Construction specialists then use the building plans to determine measurements, electrical power loads, and other counts of the building components and classify them according to the recovery periods referenced above.
  • The building components that are segregated above are then priced using “an accepted third-party pricing source” that is consistently applied to all of the building components.
  • A thorough report is prepared that explains the process and, more importantly, the tax justification for those items moved to a 5-year or 15-year recovery period.

A quality study will use specialty engineering software that can download the building plans, perform all of the engineering calculations, and determine the appropriate pricing for the calculations by linking with a third-party pricing service. This methodology results in greater accuracy and more importantly, a document that supports engineering and pricing processes in one location.

A simple excel spreadsheet with “rule of thumb” percentages used to classify the building components won’t make for a quality study, and unfortunately, there are firms that will take shortcuts and playing an “audit lottery” game unbeknownst to their clients.

Who Are the Best Candidates?
After considering the cost of the study, clients generally will receive benefits in the following situations:

  • The purchase price of the grocery store (excluding equipment) is in excess of $750,000
  • You have construction or renovation costs exceeding $250,000

One misconception is that you have to own the grocery store to be a candidate for a cost segregation study. Cost segregation studies also apply to tenant and leasehold improvements. This is seen quite frequently in situations where the grocery store was purchased or constructed and is held in a real estate entity separate from grocery store operations.

An initial analysis to determine what the benefit of a study may be should come at no cost to you. A fair amount of time should be taken to complete this analysis and obtain an understanding of what the results may be, if there are any issues that may impact the result, and most importantly, if enough value would be generated to justify performing a study.

The most important factor in determining if a cost segregation study makes sense is probably the easiest question to answer. If you are paying significant taxes and are in a higher bracket, the benefit of a cost segregation study is easier to determine. If you are in a low bracket and have most of your income sheltered through other depreciation or other deductions, then the benefit of a cost segregation study is not nearly as significant. This is probably the most important question in determining if it even makes sense to complete the initial analysis.

What Are the Benefits and How Much Does It Cost?
Typically, you can expect to move 25-35 percent of the costs of a grocery store to the shorter 5-year and 15-year recovery periods. The summary below shows actual results of grocery store studies that have been completed by Eide Bailly in the last two years:

Construction cost (1): $8,085,000
Additional first-year depreciation: $1,767,000
Tax benefit in the first year: $ 687,000
Present value of the cumulative tax savings: $ 705,000
Study cost: $ 13,700
Percentage of costs moved to 5-year and 15-year 39.8%


Purchase cost (2): $1,637,000
Additional first-year depreciation: $ 210,000
Tax benefit in the first year: $ 84,000
Present value of the cumulative tax savings: $ 61,500
Study cost: $ 8,700
Percentage of costs moved to 5-year and 15-year 24.3%


Construction cost (2): $4,125,000
Additional first-year depreciation: $ 925,000
Tax benefit in the first year: $ 371,000
Present value of the cumulative tax savings: $ 223,750
Study cost: $ 10,200
Percentage of costs moved to 5-year and 15-year 35.1%


(1)   This project was a current year project and a change of accounting method was not required.
(2)   These projects were placed in service in prior years, and the additional first-year depreciation reflects the “catch-up” of prior year depreciation that should have been claimed.  

As you can see, the costs of completing the study ranged from $8,700 to $13,700 with a current year tax benefit that significantly exceeded the study cost. Generally, it will take 50-100 hours to complete a quality study. A discount rate of 5 percent was used in the above examples to determine the value of the cash flow that resulted from the acceleration of the depreciation deductions.  

Planning Ideas
If your grocery business is showing growth in profitability and recovering from the economic challenges of the past few years, the following are examples of how a cost segregation study can be used in your continuing tax planning:

  1. You do not need to complete the study in the year your real estate investment (purchase, construction, or tenant improvements) is placed in service. You have the ability to pick the year that works best for you. The IRS allows you to take the benefit of a cost segregation study “after the fact” by filing a change of accounting method form which creates an opportunity to “catch up” on your depreciation deductions without the need for amended returns. For example, if you had constructed (or made tenant improvements) to a grocery store in 2008, you can complete a study in the current year and apply the results to the 2013 tax return without filing amended returns. If 2013 is a lower tax rate year, you can wait and apply the deductions to 2014 or a year in which you may experience a higher tax rate.  
  2. If you own your business and if the real estate is held in a separate entity, are you making the election to combine activities on your tax returns?  If you qualify, a cost segregation study can significantly increase your current year real estate depreciation deduction (probably creating a loss) that can be used against income from a pass-through entity for which you are an active participant.
  3. The new regulations requiring capitalization of repairs (unless you meet certain tests to allow for expensing) includes a provision that now allows you to write-off the building components that were removed. However, in order to claim this deduction, you have to be able to identify the original cost (i.e., an invoice) or use a method that is consistently applied to the whole building.  A cost segregation study provides the detail needed to determine the cost of the component replaced.
  4. A cost segregation study may result in a significant increase in property that qualifies for bonus depreciation if bonus depreciation was available in the year the property was originally placed in service. The results can be significant if the study is being completed when you are allowed the “catch-up” depreciation and have not elected out of bonus depreciation for the year the property was placed-in service.
  5. If bonus depreciation is not extended for 2014, the amount of remaining depreciation deductions will probably significantly decline; potentially creating surprises at tax filing time. Going back into your depreciation schedules to look for cost segregation opportunities could help mitigate this problem.   

The dollar amount of the income tax savings (and resulting cash flow) will depend on the complexity of the property and the dollar amount of the investment.  It is not unusual that the reduction in income tax liability can result in additional cash ranging from 5-10 percent of the original cost of the real estate investment.

Working With the New Repair Regulations
For calendar year taxpayers, the new repair regulations issued September 13, 2013, became effective January 1, 2014. The tax treatment for expenditures related to repairs, improvements and capital acquisitions are now most likely different than prior years.

Historically, a decision to deduct an item as a repair was often based on the dollar amount of the expenditure or the amount of the invoice. Typically, the higher the dollar amount, the greater the likelihood the amount was capitalized and depreciated. In many cases, this resulted in that item being depreciated over 39 years.

The new repair regulations are complicated, but generally are more favorable to grocery store owners than the prior rules. Starting January 1, 2014 (unless you elect to early adopt the new rules for 2013) some potentially currently deductible repair items include:

  • Replacing the rubber membrane on your roof. This is typically capitalized due to its relatively large dollar value.
  • Replacing one of four roof top units. If you replace two of four, you will probably have to capitalize the expenditure.
  • A mill and overlay of the parking lot may now be treated as a deductible repair, depending on the scope of the work.
  • Replacing up to 30 percent of a building component may give rise to a deductible repair.

Unfortunately, there are no “bright-line” tests that can apply with certainty, so each of the above examples would require some review to determine deductibility. As a word of caution, any work that is done shortly after purchase will probably result in capitalization due to the notion that you may be repairing “wear & tear” of the prior owner and not for the period of time the property was owned and utilized by you.

The new repair regulations come with some opportunities should apply to most grocery store owners:

  • To take full advantage of the repair regulations and the “de minimis” rules, we recommend grocers make the election to adopt the “de minimis” rules on an annual basis and put in place and follow the $500 capitalization threshold that is allowed. If you have audited financial statements, the $500 threshold can be moved up to $5,000 if it makes sense.
  • If you are performing repair and maintenance to your store, make sure the invoice is reviewed for the scope of work completed. With the election of the $500 “de minimis” rule, the determination of capitalizable or deductible treatment is made on a “per-item” basis and not a total invoice level. If you have an invoice for $5,000 consisting of 11 items all priced the same, the per-item costs is less than $500 and therefore probably deductible under the “de minimis” rule as each item is less than the $500 threshold for non-audited financial statements.
  • Go back to your depreciation schedules and look for items that are being depreciated over 39-years. There is a high probability that if the dollar amount is less than $10,000, the expenditure could now be expensed by applying the new repair regulation rules and filing an IRS Form 3115 to adopt these rules. This “Repair Study” can make significant deductions available.
  • If a past expenditure required capitalization, you are entitled to a “partial disposition deduction” under the new rules. For example, if you completely replaced the roof (rubber membrane, sheathing, and insulation) you no longer have to depreciate two roofs (the original roof that was being depreciated at the time that the improvement was made and the subsequent improvement that resulted in capitalization of the expenditure). The new regulations now give you the flexibility of making the election to take the partial disposition deduction which would be the cost of the original roof (either purchased or constructed) less depreciation already claimed. This is what we refer to as a “Retirement Study.”

Many of the same concepts used in a cost segregation study also apply to the application of the new repair regulations. A construction specialist who understands how a building is comprised and how to apply the “unit of property” concepts to the building components can make supportable decisions on whether a repair can be deducted currently or whether it is a capitalizable expenditure. Remember, if it has to be capitalized, you are now entitled to take a partial disposition deduction for the component removed (if it makes sense to calculate the deduction).

When completing a cost segregation study on your grocery store or working with a group that understands the new repair regulations, it is important to understand the differences in quality that providers bring to the table. You can utilize the American Society of Cost Segregation Professionals (ASCSP) as a resource and we encourage you to complete your due diligence before selecting a cost segregation provider or selecting a provider to complete a Repair and/or Retirement Study. If you receive a quote and the number seems too good to be true, it probably is.

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