Trump. Taxes. And why your business is probably
paying too much.
In a nation that began with the statement, “No taxation without representation,” tax will always be a debate in America. In 2016, the nation elected a president that appears to have fully and effectively implemented tax strategies in his own business. Those methods have likely allowed him to pay close to nothing for 20 years. While many have questioned the legal and ethical implications of this, nothing has changed. Why not? Because the president has done exactly what Congress intended! Business owners are entitled to recover the cost of their investments! This article will introduce a strategy that can help your business on the road to reducing its own tax burden.
Business owners and investors look to maximize tax credits and deductions every year in an effort to minimize tax obligation. One of the most profound strategies for accomplishing this is known as “Cost Segregation.” This strategy focusses on the depreciation of capital assets owned by a business.
So how does it work? Consider the following example: Presidential Hotels, LLC, purchases a building for $10 million. It is a commercial property that must be depreciated over 39 years. In other words, the company is expected to recover the cost of its investment over 39 years (for tax purposes). What about all the “things” in that building that contributed to its value? Sure, it makes sense if the building had concrete floors, bare windows, minimal lighting, etc; that the purchaser probably did value the building and land at $10 million.
As many business leaders can attest to, that isn’t normally the case. More often, the building included carpet, accent lighting, a receptionist desk, window treatments, and any number of other assets. Those things that contributed to the purchase price are not truly the value of that building, because if those assets had been acquired separately, they would have been valued separately!
The question to ask then is, “is it fair to value these assets as part of the building?” The answer is no! And the IRS has agreed with this logic for over 20 years! Instead of keeping all of that cost tied up for almost 40 years, your business could be recovering a substantial portion in the next 5 to 15 years! That means more money to invest in the next property or the current project!
Investment drives our economy, which is a big part of why this strategy has been accepted countless times by the IRS. Ethically speaking, cost segregation is the only fair way for a business owner to approach tax. The business will replace those carpets (I hope anyway!) before 40 years. Therefore, it makes perfect sense to depreciate those assets on a more realistic schedule.
Additionally, by identifying those assets which are not, by definition, a required part of the building, owners (and their CPA’s) are able to properly account for disposal. Why? Because they now know exactly what the tax basis of a given asset is!
Let’s assume that your depreciation schedule looks like the purple line in the graph below. The green line represents a potential depreciation schedule after having a cost segregation study performed. Those familiar with the concept of present value, or “a dollar today is worth more than a dollar tomorrow,” will understand why you want your depreciation schedule to look more like the green line. Those lines are expenses, and the years at the bottom are when owners and businesses get to recognize them on their tax returns! Expenses lower income, and we pay taxes on income! So why wouldn’t we recognize these expenses as soon as we are able?
This graph does not assume replacement of those assets that have shorter lives (many of which you undoubtedly will replace), only those assets included in the original purchase. Without a cost segregation study, disposal of those assets can be extremely difficult. How can you assign a dollar amount to an asset with an unknown cost? This is where the additional “hidden” value is found in having a cost segregation study performed. Even without considering the tax savings, there is a substantial benefit in knowing what each piece of your property is worth!
The only concern that I normally hear from owners and business leaders, is that they are concerned about the complications of another tax concept: recapture. Recapture is essentially, having to pay back-taxes on disposal of an asset for which you have taken accelerated depreciation. I am here to tell you that it receives far more negative attention than it should! This is because it is commonly handled improperly following a cost segregation study. Most of the negative effects can be minimized, and in some cases may even prove beneficial! I will address this concept in a future article, but my final advice is the following: Choose your tax consultant carefully!
Written by: John Gail, Project Manager | CSG: Strategic Tax Consultants | 21 Sept 2017
[Circular 230 Disclosure: This analysis is not tax advice and is not intended or written
to be used, and cannot be used, for purposes of avoiding tax penalties that may be
imposed on any taxpayer.]