Buried tax savings

Here's how to mine cash from your dealership real estate New revenue procedures provide an opportunity to safely and easily reap cash from your dealership's real estate investment.

The cash windfall is created by increasing your tax deductions for depreciation by performing an engineering-based cost segregation study. This analysis involves properly identifying costs included in the construction of your facility that qualify for shorter recovery lives than the building itself.

If you constructed or purchased real estate in a prior year and did not take advantage of the benefits of an engineering-based cost segregation study, you can obtain tax deductions (over a four-year period) by doing such an analysis currently. If you constructed or purchased real estate in the current year, this analysis can substantially reduce your current tax bill.

These buried tax savings can be mined from:

* New construction

* Renovation, remodeling, restoration or expansion of existing facilities

* Purchase of existing properties

* Leasehold improvements

* Post-1986 real estate construction, building acquisition or improvements

Simplified procedure now available Revenue Procedure 96-31 provided that a taxpayer's depreciation deductions constitute an accounting method . . . and to the extent the appropriate methods were not used (and more than one tax return was filed using the "erroneous" method), the taxpayer may file an accounting change request (Form 3115) to adopt the "correct new" method.

More recently released Revenue Procedures 98-60 and 99-49 now allow you to file Form 3115 by the due date for filing your current year's tax return, and the change will be automatically effective for the current year. The need to apply for IRS approval has been eliminated for taxable years ending after December 27, 1999. The procedure has thereby become greatly simplified and subject to less scrutiny by the IRS.

Value of breakdown Experience has shown that approximately 7-10% of the construction costs of a dealership facility can qualify as personal property and 20% to 25% as site improvements.

The personal property qualifies for a 5-year write-off using the 200% declining balance method, and the site improvements a 15-year write-off using the 150% declining balance method for depreciation. The deductions can be maximized by using the accelerated methods in the early years and switching to the straight-line method at the point in time when a larger deduction would result from the use of this method.

The accompanying table shows the cash flow benefit that can be derived from segregating the cost of personal property and site improvements from the cost of a dealership facility with a total construction cost, excluding land, of $2.5 million; 81/2 % of the cost ($212,500) allocated to personal property and 22% ($550,000) to site improvements.

The cumulative cash flow benefit from cost segregation is almost $330,000 in the first 15 years of the life of the facility.

Engineering study needed Many dealers and their accountants have used contractor and accounting estimates to attempt to segregate the cost of these shorter lived assets. But this approach has been consistently and successfully challenged by the IRS for lack of adequate support. In addition, the use of this approach will usually result in substantially lower deductions.

A proper cost segregation analysis requires a detailed listing of the fully installed cost of each item of personal property and of the site improvements, including an allocation of soft costs, e.g., the contractor's indirect costs and other indirect costs (such as architect and engineering fees).

For newly constructed properties, an engineering-based study is performed by thoroughly analyzing the con-tractor's cost documents and construction floor plans.

For purchased properties, where construction documentation is not available, costing methods satisfying cost segregation requirements are known as survey or unit-in-place methods of determining the reproduction or replacement cost new (RCN) of the building, its improvements and site improvements.

The RCN values are then adjusted based on a deduction due to the economic effects of physical deterioration and economic obsolescence. The purchase price (less land value) is then allocated on a pro-rata basis to the depreciated RCN values. The IRS approves of these methods.