Article

Opening a new restaurant? Consider a cost segregation study

Oct. 19, 2023 · Authored by Ty Riley

New restaurant owners frequently ask “How can I find more tax deductions to offset my tax liability and increase cash flow?” Even the most astute taxpayers who implement effective tax planning measures still ask this common question. There is an unexpected option that may help — real estate! A restaurant owner’s new building can be a great way to accelerate tax deductions to offset taxable income and increase cash flow. The method used to determine the tax deductions from the real estate is called a cost segregation study.

A cost segregation study analyzes real estate (39-year assets) to identify the land improvements and personal property (15-, seven-, and five-year assets) to be reclassified to shorter tax lives. Shorter tax lives can accelerate tax depreciation expenses, reducing taxable income and the resulting tax liability, and improving cash flow. For the restaurant owner, real estate includes the construction of a new restaurant, the purchase of an existing restaurant, or a renovation of a restaurant. A cost segregation study applies to any taxpayer who owns real estate and expects to pay federal or state income taxes. However, if the taxpayer reports a loss, the results of the study would increase the net operating loss (NOL) which can be carried forward to offset future tax liabilities.

Fortunately, it is never too late to perform a study. If the construction, purchase or renovation of a restaurant occurred in a previous tax year, an analysis can be performed on the fixed assets that were already placed into service and recorded on the tax depreciable schedules. The analysis reclassifies land improvements and personal property in the current year but considers the accumulated depreciation that was reported in previous tax years and brings forward or “catches up” the deductions with a 481(a) deduction that is reported on a Form 3115. This is an automatic change in accounting method and does not require an amended tax return. Although assets may be examined dating back to 1987, a more practical approach would be to go back no more than 10-15 years.

There are many benefits that a restaurant owner can achieve by performing a cost segregation study. The acceleration of tax deductions in earlier years benefits taxpayers with the time of value of money. It also provides immediately improved cash flow by lowering taxable income resulting in less tax paid by taking advantage of the current tax rules regarding 80% bonus depreciation in 2023. Bonus depreciation allows taxpayers to initially deduct a large amount of the purchase price of an eligible asset and depreciate the remaining amount over the tax life of the asset. For example, if five-year bonus eligible restaurant equipment costs $2,000, then 80% of the basis ($1,600) can be deducted immediately and the remaining basis ($400) will be depreciated over five years. Bonus eligible items are new or used assets that are acquired that have a tax life of twenty years or less.