LESS TAXING: Cost segregration can save you plenty on a build-out.
Q. We will be finishing construction on a new restaurant in early 2006. The entire-build-out, including furniture, fixtures and equipment, will cost approximately $1.2 million. I am being told that I will not receive much of a write-off relating to the build-out. Can you tell me what kind of write-off I should expect?
A: First of all, the write-off you will be receiving will be depreciation. Restaurant personal property should be depreciated over five years. Real property will be depreciated over 39 years, so it's important to be able to allocate as much of the build-out cost to personal property as possible. Any land improvements entitle you to 15-year depreciation on those assets.
You will receive a first-year depreciation of 20 percent of the cost of the property. However, the company may be eligible under Internal Revenue Code Section 179 to write off up to $105,000 (in 2005) on its personal property. Such a write-off is limited to the taxable income of the company. Also, if personal property additions are greater than $400,000 in any one year, the $105,000 allowable amount begins to phase out.
The most common mistake made by restaurant owners (and most accountants) is that they treat the entire amount of the construction costs incurred by the general contractor as 39-year property. In your example, if $900,000 of the $1.2 million cost is related to the general contractor costs, most restaurants would automatically depreciate this over 39 years.
Under a method commonly referred to as "cost segregation," a restaurant can segregate electrical, carpentry, plumbing, HVAC and other general costs into both personal (five year) and real (39 year) property. Prior court cases and an IRS directive support the process of cost segregation. Be sure to use professionals who are qualified to perform the cost segregation and prepare the appropriate documentation.
It is quite possible that you would be able to allocate 40 to 50 percent of the $900,000 general contractor costs to personal property. As such, if 50 percent were allocated, you would be able to deduct $450,000 of depreciation in the first five years of your restaurant versus only $57,700 [($450,000/39 years) x 5 ] if there was no cost segregation. This $400,000 of accelerated depreciation could likely save you up to $160,000 of federal and state taxes in the first five years.
If you have opened a new restaurant in the past and did not do cost segregation, it's not too late. Feel free to contact me with any questions about cost segregation.
Adam M. Berebitsky, CPA, is Director of Tax for SS&G Restaurant Services Group, a subsidiary of SS&G Financial Services, Inc. Reach him at (800) 869-1834, or ABerebitsky@SSandG.com.