Cost Segregation for Restaurants and Hotels

Jul 14, 2021

By John Toth, Tax Shareholder

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Need a Cost Segregation Study?

If you own a restaurant or hotel establishment, the answer most certainly could be “YES!” As a tax accountant with clients in this space, I urge you to consider conducting a cost segregation study to maximize your tax deductions. In this blog post, I will go over what this study does, when to get it done, and what benefits you will realize for your business.

The Process of a Cost Segregation Study

When you buy a brick and mortar building for your restaurant or hotel, the default IRS rule says that you must depreciate (write-off) the cost over 39 years. In other words, each tax year, you get to expense 1/39th of the purchase amount. A cost segregation study helps you accelerate this process. Basically, it involves a team of engineers who will assess your facility, do an onsite walkthrough, take pictures, perform a comparative analysis to other buildings, and identify those components that can be broken out as having lower tax lives. Some components may be determined to have a 5-, 7-, or 15-year tax life, depending on the type of item (equipment, decorative light fixtures, millwork, plumbing, signage, etc.); all of which will appear as segregated line items in a final report.

The Timing of a Cost Segregation Study

There are several opportunities to take advantage of this tax strategy. The best time to have a cost segregation study done is when any of the following occur:

  • You are starting from land or dirt to construct a brand-new facility 
  • You are purchasing an existing building
  • You are doing your own buildout of a lease space, from a shell
  • You are remodeling after years of being in business

The Benefits of a Cost Segregation Study

When you are able to classify these expenditures to shorter tax lives, you get to take deductions faster. While it’s always better to do so as soon as possible, it is especially helpful to your cash flow when starting a new restaurant or hotel business, or making a related capital investment (described above). Undertaking a cost segregation study becomes most beneficial when the project costs exceeds $1 million, as it will be a significant amount of savings, making the costs well worth it. Under the new Tax Cuts & Jobs Act, assets that have a tax life of less than 20 years are eligible for 100% bonus depreciation, meaning you will get a full deduction from the date these assets were placed in service.  In addition, the recent CARES Act changed the law to allow 100% bonus deprecation on qualified improvement property.  Previously, this type of property had a 39-year tax life and was depreciated agonizingly over that time period.  This was a huge win for the retail industry, because now the cost of tenant build-outs done after a building was first placed in service could almost all be written off in year one.  

What’s Next

Now that you know what it is and why it’s a good idea, you will need to find a third-party firm that offers cost segregation study services. There are companies that specialize in this exclusively, and others do an assortment of studies (including tax incentives and credits), such as R&D studies. They typically have a sales team, a technical engineering team, and sometimes tax attorneys for consultation. It is often the case that your accountant would be the liaison to help select and then work with the cost segregation study folks.

You will be expected to provide an outline of the true cost of the facility, buildout, remodel, etc. This can be in the form of a closing statement, in addition to ancillary costs. Note that if you are expanding to open multiple facilities, this information can be duplicated to receive the same tax advantage for each location. 

Another plus for using a specialized team to do your study is that they offer audit protection along with their report, in case anything goes wrong and you need IRS representation. 

Summary

Houston has the most restaurants per capita in the nation, with new ones popping up all the time. This is also one of the most difficult businesses to be successful in, particularly when introducing a new concept where an old place failed. In such challenging start-ups, the tax savings from cost segregation become critical to increase cash flow and lower your tax burden when you need it most—in the first years to get up and running.  Weinstein Spira understands this process and its tax benefits. We can recommend the names of reliable companies we have worked with in the past who do a good job and provide a good service.  Contact us for help in finding the right firm to conduct your next cost segregation study.

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Category: Tax