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Will Cost Segregation Reduce Your Tax Burden?
Dentists who own their facility should consider this technique
With interest rates at an all-time low, many dentists have chosen to purchase the facility that houses their dental practice. Although the dentist may have been told by their certified public accountant (CPA) that the building, along with its components, would have to be depreciated (expensed) for tax purposes over a 39-year period, there is a bit of good news here.
This is where some tax planning can come in handy for you. The dentist can engage a Certified Engineer to perform a cost segregation study, the results of which can allow him/her to accelerate the depreciation of portions the building he/she now owns over a much shorter timeframe than the usual 39-year period (Table 1).
How Cost Segregation Works
Cost segregation allows the taxpayer to shift a portion of the depreciable basis of their building from a 39-year life (for tax depreciation purposes) to 5-, 7-, or 15-year life property. By reducing the lives of the components of the depreciable portion of your facility, you can accelerate your annual depreciation tax deduction and reduce your related income tax liability. By doing so, you will generate immediate cash flow from the related tax savings from the cost segregation study.
So how does cost segregation work? The engineer will determine which components of your building qualify for the shorter depreciable lives. If you still have your blueprint from your build-out or the construction of the building, this will accelerate the process and reduce the associated professional fees.
The cost segregation study will determine the tangible personal property and land improvements portions of your building, even though the total cost of acquisition is reported on your balance sheet as building costs or leasehold improvement costs.
The engineer will generate a formal report that segregates the building assets into four major categories:
• Tangible personal property. Examples include carpeting, fixtures, plumbing and electrical systems, and window treatments. This category can be depreciated using a 5- or 7-year recovery period, producing significant tax savings when compared with the customary 39-year period.
• Land improvements. This category can include sidewalks, fences, driveways, and significant landscaping. This category is also subject to an accelerated depreciation method with a typical recovery period of 15 years, again producing useful tax savings.
• The building. The engineering report will assign separate values to various components of the building over and above the tangible personal property and the land improvements. In some cases, there is an opportunity for accelerated depreciation here as well.
• Land. Once the above three categories are allocated, the balance of the purchase price is allocated to land. The value for the land portion will generally be low or have an insignificant value; it will not generate significant tax savings since land is not depreciable.
Consider Timing and Cost
You may be saying to yourself, “I wish I had known about this, say, 5 years ago when I purchased my building.” There is some good news—the Internal Revenue Service will allow you to use cost segregation as long as you have a Certified Cost Segregation Study performed. You then file an amended income tax return for the year in which the study was completed. This amended return takes into account all the depreciation to which you were entitled, including previous years’ additional depreciation not previously taken. This technique could create significant tax savings in the year you file the amended income tax return.
The cost of the cost segregation study should be considered before you put “pencil to paper.” You want to make sure there will a cost benefit in the form of income tax savings before incurring the cost of the study.
It is important to engage a dental CPA who is familiar with the cost segregation process. Within a typical dental practice, you can expect the assets that qualify for this special depreciation treatment to range from 15% to 40% of the total building cost. The tax savings could significantly offset the costs of owning or constructing your facility. By doing so, you will be able to afford to own the dental facility that houses your dental practice, and build “wealth” at the same time.
About the Author
Allen M. Schiff, CPA, CFE, is the owner of Schiff & Associates Dental CPAs (www.schiffcpa.com). With more than 35 years of experience in dental practice management, Mr. Schiff provides clients a range of business planning services that includes obtaining financing, succession planning, and developing exit strategies, as well as long-range transitional planning. He is an accomplished speaker on all areas of dental practice management and is a founding member of the Academy of Dental CPAs (www.adcpa.org). He can be reached at 410-321-7707 or email@example.com.