Cost-segregation can help dealers recoup hidden money
For dealers, it's a best-kept secret for recouping hidden money at tax time.
It is an understanding of tax depreciations through cost-segregation studies of building expenses and renovations.
Cost segregation is an Internal Revenue Service-approved method of re-classifying components and improvements of a commercial building from real to personal property.
This process allows the assets to be depreciated on a new 5-, 7- or 15-year schedule instead of the traditional 27.5- or 39-year depreciation schedule of real property, according to CSSI Inc., cost-segregation specialists in Baton Rouge, LA.
Cost segregation is essentially a depreciation, or tax deferral, for business owners that allows an accelerated method of depreciation.
Many dealers don't know about the new rules. Nor do they understand how cost segregation can save them hundreds of thousands of dollars through engineering-based cost-segregation studies, tax experts say.
The method is one of the IRS' cash-flow secrets that certified public accounts, financial planners, real-estate investment managers and other professionals have used to help dealers realize tax savings, especially at a time when cash is in short supply.
“I honestly don't know why not many dealers are doing cost-segregation studies,” says Iowa dealer Nick Nichols, who operates Noble-Mercury in Indianola and Noble Automotive (Ford, Lincoln Mercury, Chevrolet and Cadillac) in Newton. “Tax savings is the whole purpose.”
Nichols has conducted two cost-segregation studies in the last two years — one on his remodeled Indianola facility and the other on the Newton stores.
He spent $5,000 on the first engineering study (remodeled facilities tend to cost less to evaluate) and $7,000 on the second, a full study.
He considers it an excellent return on investment, considering he got about $240,000 in tax refunds. “The benefits far outweighed the costs,” he says.
He leaves the financial details to his accountant and contracted engineers who do the studies.
“Dealers can increase their bottom-line savings, or recoup as much as 25% of the building's value within the first five years of ownership,” says Jim Shreve, president and founder of CSSI.
“Some of the leading auto dealers today are taking advantage of cost-segregation studies to accelerate their depreciation deductions and decrease their taxable income,” Shreve says.
Many dealers learned about it after consulting with financial advisors who were abreast of the latest legislation.
The current tax law allows dealers to recoup 6%-8% of building costs, alone, in tax savings. The law also applies to buildings that have been purchased since 1987.
Example: If a building cost $1.5 million, excluding land, cost savings to a dealer can be $90,000-$120,000. (See table, next page)
Shreve also gives this scenario: Dealers or businesses with building costs of $3 million, excluding land, can reclassify 29% of the property to a shorter recovery period, meaning huge tax savings and additional depreciations.
New legislation makes it possible to identify a dealer's components and improvements to a commercial building by reclassifying it from real to personal property, Shreve says.
This means the assets can be depreciated on a shorter-term schedule than before.
Congress passed the bonus depreciation and Sec. 179 extensions for 2009 in February. The original provisions were passed in March 2002 and have expired several times.
Law makers found different reasons for bringing the provisions back or extending them, says Jason Duffner, CPA and tax analyst with LarsonAllen LLP.
Changes to the tax law combined with a large number of dealership construction and renovation projects can lead to significant tax savings, Duffner says.
High-volume dealers typically spend $12,000 to $25,000 in professional fees to complete a cost-segregation study, not including personal or employee time.
LarsonAllen has performed more than 500 engineering-based cost-segregation studies since 2001 on about $1.6 billion of real-estate assets. About 90 of those have been dealership related.
The company typically assists dealers who either have purchased or constructed a building in the current year or in the past 5 years.
Pete Kelly, former general manager of Hendrick Automotive Group in metro Atlanta, is a proponent of cost segregation, saying its value to a dealership's bottom line is an untapped treasure.
“Every dealer is looking for capital,” says Kelly, a 24-year automotive veteran. “Everyone is in dire need of cash. It's beyond me why more dealers are not looking to do cost segregation.”
Dealers going through terminations by auto makers especially need to do cost segregation, he says. “These dealers will miss a huge opportunity if they don't.”
Many CPAs don't understand the details needed to recapture lost depreciations. “Dealers in today's climate need a certified cost-seg engineer to come in and do a full analysis,” Kelly said.
A thorough study will cover all parts of an operation — from new facilities, remodeling, wiring, lights, carpeting, wall coverings, paint, fixtures and many related costs.
Costs can be depreciated on a pull-forward basis instead of the old tax model, which meant waiting up to 27.5 or 39 years to recoup costs.
Hundreds of items in dealership operations and other industries can be depreciated and pulled forward under new legislation, says Kelly.
There's also help in the tax code for terminated or closing dealerships.
The new federal legislation will allow a dealer, for example, who recently was terminated to expense or deduct the remaining net tax basis of the building investment, Duffner says.
“We're hoping to see another portion of legislation make it through Congress, which would expand the 5-year Net Operating Loss (NOL) carry back to a larger amount of dealers,” he says.
Duffner cites a caveat: “There has to be considerable coordination with a dealer's CPA to properly determine the tax benefits. You simply can't just look at a building to determine if you will actually generate any tax savings by accelerating tax depreciation.”
Dealers considering cost segregation need to be aware of the differences in approach.
“The IRS is taking an aggressive look at what some taxpayers are trying to do with cost-segregation studies,” Duffner says. “We highly recommend an engineer be involved with the process, rather than making accounting estimates.”
Too many tax professionals just don't get it, says Jim McDonald, principal of McDonald and Associates, with its Tax Recovery Specialists LLC group in Atlanta. “The problems for some CPAs is they can't find anyone to depend upon and don't have access to good cost engineers.”
From a dealership standpoint, he says, dealers might be “frustrated because they're not able to find qualified specialists who will stick around to defend a case,” if needed.
Some dealers assume a loss is a loss. “That's a lame excuse,” McDonald says. His firm charges only if the dealer receives tax savings, and that's a 20% fee of the earnings.
“The key is to analyze each situation and determined if you have a good client candidate,” he says. “You don't know if you have a candidate until you assess each situation — and that service should be free.”
Dealership Tax Savings by Cost Segregation
|Building cost||Tax savings|
Source: CSSI Inc., Baton Rouge, LA