Cost segregation involves the reclassification of building components from a standard 39-year depreciation schedule to a shorter, accelerated depreciation schedule as allowed by the IRS. Typical shorter depreciation life includes 5 years, 7 years, or 15 years. Faster depreciation allows commercial building owners to maximize cash flow and minimize tax liability, generally saving about $70,000 for every $1 million in building cost.
This is a well-accepted procedure by the IRS, yet many small to mid-size hotel owners have been slow to embrace it in the past years. Generally, it is because of a lack of awareness of this tax-saving strategy. This is now changing as more independent and franchisee hoteliers are discovering six-figure savings as a result of conducting a cost segregation study.
Why is a Cost Segregation Study Beneficial to Hoteliers?
Own vs. Lease:
A cost segregation study can be useful in many ways for hotel owners. Unlike many other business segments, such as retail, restaurants, etc., where it is quite common for the business owners to lease their space, a larger percentage of hoteliers tend to own their property. After all, owning the real estate is part of the appeal in the hotel and motel business.
Building “density” matters:
Generally speaking, “denser” buildings are likely to have more components that qualify for accelerated depreciation. For example, if you compare a hotel that sits on 1 acre of land with a warehouse that sits on 1 acre of land, the hotel will be the clear winner when it comes to maximizing accelerated depreciation and getting the biggest “bang for the buck” from a cost segregation study. This is because a warehouse building is comprised mainly of four walls and a roof and has a small amount of office space. The majority of the value of the warehouse property is embedded in the land rather than the building. Land is an appreciating asset, and therefore, does not qualify for any kind of depreciation. The hotel in our above-mentioned example is more likely to be a multi-story building with complex electrical systems, specialty plumbing, flooring, partition walls, landscaping, carpeting, and many more components that would make it an ideal candidate for cost segregation study. The ratio of building cost to land cost, works in the hotelier’s favor.
Furthermore, in the competitive hospitality business, periodic large-scale renovations and rebranding are required to meet guests’ rising expectations. Building renovations over $500,000 will often be eligible for additional accelerated depreciation benefits, regardless of how old the building is, or when it was purchased!
Cost Segregation Process:
Fortunately, the process doesn’t require much time or effort from the hotel owner.
Initial Evaluation: The first step in the process is a brief consultation with a business advisor, who will help determine if the particular hotel qualifies for cost segregation.
Benefit Calculation & Proposal: A cost segregation engineer will review the building depreciation schedule, review the type of building, calculate the benefits, and develop a proposal.
Site Visit & Final Engineering Report: Once the client has accepted the proposal, a site visit is conducted, and the final cost segregation study is drafted. The report is provided to the client and the client’s CPA, who then proceeds to capture the benefits by filing on behalf of the client.
If you are a hotelier who has purchased (or constructed) a hotel or motel for over $1 million within the last 15 years, or have conducted a recent building renovation for over $500,000, then you should evaluate if cost segregation is right for you. A cost segregation study is not the right solution for everybody, and other factors need to be considered upon making this decision. Learn more about cost segregation studies by clicking here.
Vinil Ramchandran, is the President of AcuSolutions, a cost recovery consulting company that helps commercial property owners capture tax benefits through a cost segregation study. You can contact him at (323) 989-2281, or firstname.lastname@example.org, for a FREE, no-obligation evaluation to help determine your potential benefits with a cost segregation study.