Building or remodeling your automobile dealership? Do you want to reduce your federal tax liability?

August 3, 2015

If you answered ‘yes’ to these questions then a cost segregation study might be worth considering…

A cost segregation study analyzes a building and identifies the components that qualify for shorter federal tax lives than the 39-year life (straight line depreciation) required for automobile dealerships. These shorter lives are depreciated at an accelerated rate of 5, 7 or 15 years, providing a larger current depreciation expense – which in turn reduces federal taxable income.

Some common five-year automobile industry qualifying items include:

  • decorative bollard lighting
  • carpeting
  • removable cabinetry 
  • compressed air systems and piping 
  • vehicle exhaust systems 
  • equipment related electrical connections 
  • decorative lighting fixtures such as track lighting and accent wall lighting.

Other tax lives in the automobile industry are seven-year: exterior site lighting fixtures and poles; and 15-year: exterior sitework and improvements.

Bonus depreciation of 50% was extended again for in service dates up to January 1, 2015.

What does this mean for cost segregation? It means you can write off 50% of the cost of new depreciable assets with a tax life of less than 20 years in the first year of service. This includes all property identified as 15-year sitework, in addition to five- or seven-year personal property. The result is a significantly increased depreciation expense.

On September 13, 2013, the Treasury published final “repair” regulations that expanded and clarified the rules surrounding capital expenditures. These took effect January 1, 2014. The new rules:

  • refined the definition of “unit of property,” establishing a facts-based approach to determining whether work performed on a building or leasehold improvements should be considered a deductible repair or a capital expense.
  • allowed the routine maintenance safe harbor to now apply to buildings (the final regulations use 10 years as the time period in which you must reasonably expect to perform the relevant activities more than once).

The Treasury also issued final regulations on the disposition of depreciable property. The “disposition” regulations provide rules for determining gain or loss upon the disposition of depreciable property, determining the asset disposed of, and accounting for partial dispositions. They apply to tax years beginning on or after January 1, 2014.

An engineering-based cost segregation study provides the framework for properly set-up and maintaining real property depreciation records for both capital expenses and deductions in regards to federal tax.

Scenario

A taxpayer constructs a new automobile dealership in 2015 for $4 million (excluding land and personal property).

If no study is performed:

The taxpayer enters the entire cost into their fixed asset system as a one line description ‘building’ as 39-year property. After the first five years, they have a total of $465,880 in accumulated depreciation expense.

With a cost segregation study:

The automobile dealership is reclassified into $680,000 of five-year property, $80,000 of seven-year property, $600,000 of 15-year property, and $2,640,000 of 39-year property.

After the first five years they have an additional:

  • depreciation of $770,000
  • deferred taxes of $308,000
  • overall present value benefit of $235,000.

Analysis:

The engineered-based cost segregation study provides detailed fixed asset schedules that satisfy 263(a) regulations for properly identifying building components which can be used for future dispositions. In addition, it increases the accumulated depreciation expense (first five years) by $305,000. The study results in an overall present value benefit equivalent to $235,000, which means greater cashflow and increased ability for near term capital investments.

Updates

In recent years, the IRS published a series of Field Directives identifying other items that qualify. Although the directives are not official pronouncements of the law or IRS position, they provide valuable guidance for a broad range of industries. Along with the IRS Audit Technique Guide from 2004, the IRS is now scrutinizing cost segregation more closely, reinforcing the need for well-documented studies such as those we provide.

Now is the time to ask our professionals for help. Contact your account director or any member of our Real Estate & Construction team.