Owners/operators of healthcare facilities (laboratories, physician offices, assisted living and long-term care facilities) must continually be adding new or improving existing facilities to keep up with growth, changing technologies and patient needs. These facilities require substantial financial investment and give rise to significant tax benefits which I and co-author, Robert Rahner, CFA, ASA, CCSP, will discuss in this blog.
The capital budget typically involves financial modeling to maximize revenue, minimize expenses and maximize cash flow after income taxes on the profit. One mysterious element of this analysis that is generally not optimized are depreciation deductions. Land is non-depreciable and the rest is typically written off over 27.5 years for residential rental properties or 39 years for all other properties. That is a long time to wait to write off your investment.
Cost segregation is an engineering-based tax strategy that decreases federal income tax liability by maximizing depreciation of select assets in a building. Instead of the usual 27.5/39 year structural building depreciation, cost segregation reclassifies assets designated by the IRS as “personal property” and “land improvements” that can be immediately expensed under bonus depreciation rules or depreciated over 5, 7, or 15 years. It is common to be able to reclassify more than 20 percent of an acquired or constructed property to these shorter recovery periods.
Examples of 5/7-year personal property assets include:
- Specialty healthcare equipment/improvements
- X-ray shielding
- Carpet/wood/laminate flooring
- Specialty millwork/cabinetry
- Electrical/plumbing dedicated to equipment
- Specialized lighting
Examples of 15-year land improvement assets include:
- Asphalt/concrete paving
- Fences/retaining walls
- Underground storm drainage
When can it be done?
A cost segregation study can be performed on new construction, acquisition, or an improvement to previously owned property. While a study can be performed retroactively, years after the fact, the best time to perform a study is during construction. Better yet, the most effective cost segregation studies typically begin during construction plan and design.
What if I don’t have much info?
Basic floor plans and a survey are helpful but not required. Other descriptive information such as an appraisal are also helpful but not required. Cost segregation specialists can estimate the relative value of the property components through a detailed site visit so limited information is not a problem that a qualified cost segregation engineer cannot overcome in reaching a positive outcome for the property owner.
Do all properties qualify?
Tax advantages of a cost segregation study vary by property type. Generally, property with cost basis of at least $1M will be cost effective and justify the analysis. Actual tax savings will depend on the specific assets and land improvements in and around the building, but the following table lists estimated savings that may be achieved for typical properties ($5M cost):
How do I determine if my property qualifies?
The process of determining if a particular property would qualify for a cost segregation study is quite simple. In fact, an estimate of savings for specific properties can be prepared with minimal information including:
- Purchase Price/Total Construction Cost/Date
- Depreciation schedule (if previously owned)
The Tax Cut and Jobs Act has created exciting new opportunities including the ability to immediately expense (100% bonus depreciation) a large portion of an acquired building starting after September 27, 2017. Prior to tax reform, only new construction projects were eligible for bonus depreciation and that was at a lower rate of 50 percent of qualifying costs. For a $5,000,000 purchase, this provision translates into expensing $1,000,000 in the year of acquisition for a typical property.
The Act also significantly increased benefits associated with section 179 expensing by increasing the limits from $500,000 to $1,000,000, and expanding eligible property to include roof, HVAC, fire protection/alarm and security system.
Cost segregation is a valuable tax tool that should be explored for any commercial property. The resulting tax savings can significantly increase cash flow for property owners.