Cost Segregation Depreciation
Bruce Bryen, CPA, CVA | November 6, 2015
Cost segregation depreciation is one of the hottest subjects out there, and few dentists or their advisors are aware of it.
In the more than 40 years of working with dentists, I have seen investments in real estate appreciate but not do much for immediate tax deductions. The depreciation write-offs are long term and while typically a safe investment, the income reductions from depreciation are not as dramatic or as apparent as equipment depreciation. The idea of using cost-segregation depreciation changes that. There is more to do when acquiring or constructing the dental office using this approach so the cost of building or acquiring should be at least in the upper $300,000 range to make the concept purposeful and cost-effective. The following gives some insight and suggestions for how to receive value benefits. Included are points needed to comply with guidelines in the event of a tax audit.
What Is Cost Segregation Depreciation?
When errors occur, they tend to be during implementation. Here is how cost segregation depreciation works. A commercial building acquisition or construction, such as a dental office, has a guideline life of 39 years for IRS approval for allowable depreciation write-offs. If a building and its improvements cost $780,000, depreciation can occur over 39 years at a rate of $20,000 per year. Using the cost segregation method and writing off specialty identifiable items that can be depreciated economically over a shorter life span than the structure of the building, depreciation can be taken in a lesser time frame. Some of these assets may have economic lives of 5 years, some more or less, but none have economic lives as long as 39 years. If $100,000 of the $780,000 acquisition is depreciated over 5 years, those asset categories generate a $20,000 deduction the first year. Specialty lighting, cabinetry, partitions, and other purchases segregated from the structure of the building have shorter economic lives and generate quicker depreciation write-offs. These deductions translate into a present value well in excess of waiting the full 39 years for those benefits. What does a $20,000 write-off mean in today’s dollars on the specialty items if a dentist is in the 50% tax bracket? The tax savings are $10,000 today on $100,000 of the $780,000 alone. If another $280,000 of the $780,000 could be depreciated over 7 years, the dentist could see an additional $40,000 write-off in the first year. This equates to $20,000 in tax savings. So in this example, a dentist would have $10,000 in hand plus another $20,000 and still have $400,000 ($780,000 minus the $100,000 and the $280,000) left to depreciate. That $400,000 depreciated over 39 years would generate an additional $10,000 or more in depreciation, meaning another at least $5.000 in first-year tax savings.
How does that yield more in today’s money? What has to be done to achieve cost segregation depreciation?
Knowing what present value represents is the key to depreciating real estate using the cost-segregation method. Remember that depreciation is the same on the $780,000 no matter which method is used. With conventional depreciation, it is worth $20,000 per year, or a tax savings of $10,000, for someone in the 50% tax bracket. With this example, for 7 years, an average of $65,000 per year in depreciation is achieved. This equates to a tax savings of $32,500 per year ($65,000x50%) for each of the first 7 years. The comparison between conventional and cost segregation would then generate $32,500 minus $10,000, or $22,500 additionally times 7 years or $157,500.
What does the dentist do with the money? Will it be used to retire debt, fund retirement, or enjoy life a little more?
What needs to be done to substantiate cost-segregation depreciation?
A critical need is the use of an engineer’s study that allocates the various asset classes of the building. It’s used to substantiate the segregation of cost. No short cuts should be taken. A firm with experience in this approach to asset allocation is a must. The dentist should speak to a dental certified public accountant and begin discussions to understand the value of money today versus waiting 39 years to receive the funds.
About the Author
Bruce Bryen is a certified public accountant with more than 40 years of experience. He is the principal in the firm of RKG Tax and Business Services, LLC, located in Fort Washington, Pennsylvania. Mr. Bryen specializes in retirement planning design, income and estate tax planning, determination of the proper organizational business structure, asset protection, and structuring loan packages for presentation to financial institutions. For more information, please visit www.rkgcpa.com.
