Unlocking Cash in the Walls of Your Practice
Over the past few years, we at ATS have been approached by doctors and dentists to help reduce tax liabilities. For practice owners, the cost segregation strategy has been a no-brainer.
Cost segregation allows building owners to accelerate depreciation schedules and create large tax deductions. When coupled with new bonus depreciation rules and provisions of the CARES Act, a cost segregation analysis can generate large tax refunds. This article provides an overview of how cost segregation (“cost seg”) works and how it has been leveraged by practice owners.
The most common method for depreciating a building is called straight-line depreciation over 39 years. This is because buildings are normally considered Section 1250 real property. Cost segregation allows components of a building to be reclassified as Section 1245 personal property. This allows the value of certain components to be accelerated to 5, 7, or 15-year life, thus frontloading the depreciation deduction. Components that can be accelerated are numerous and can range from paint on the wall to lights in the ceiling. Every component has an assigned dollar value. When the dollar values of eligible components are quantified, substantial tax savings can be achieved.
To illustrate, lets assume Dr. Jay and Dr. John own a dental practice. They have been able to grow their practice over the years and are looking to expand their facilities. They acquire a new building for $1 million dollars. They also pay $250,000 for custom improvements prior to moving in. Under straight-line depreciation, the doctors are able to deduct $32,051 per year from their taxable income.
Dr. John decided to have a cost segregation analysis performed on their building. The study finds that roughly 45% of the building can be accelerated from 39-year to 5-year life. Using bonus depreciation, Dr. John and his partner can now claim $562,500 in deductions for the current tax year. At a top marginal tax rate, this results in a tax savings net gain of $323,573 from using cost segregation.
In 2020, the CARES Act further expanded cost seg benefits by allowing losses incurred after 2018 to be carried back for 5 years. Going back to our example, let’s say that Dr. Jay and Dr. John use the $562,500 to reduce their net income in the current year to a loss of $200,000. That loss could be applied to prior years where taxes were paid on income. This would reduce the taxable income of the practice, as well as the taxes owed. If their practice is a pass-through entity, Drs. Jay and John would each receive a refund check for tax overpayments.
Unfortunately, many cost segregation providers produce deductions that doctors and dentists cannot fully utilize. This is due to limitations on passive losses from real estate. Fortunately, if you run a practice out of a building you own, these loss limitations could potentially be bypassed through a strategy known as grouping. A cost seg provider who can leverage both accelerated depreciation and grouping can create large active losses that result in substantial tax savings.
Cost Segregation is just one of the tax strategies that doctors and dentists have begun to adopt to generate savings for their practice. The process of identifying and quantifying qualified property requires nuanced expertise. The cost seg experts at ATS have been performing engineered studies nationwide for over 15 years. If you or your client own a practice and have purchased a building within the last seven years, please feel free to contact ATS for a free analysis of potential tax savings.