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Tax Deductions: Understanding Renovations and Improvements


By Marky Moore, CSBA, LEED AP, CEO Capital Review Group
November 2011

IntroIn today’s competitive hospitality market, it’s essential to approach improvements and renovations with a comprehensive strategy and an understanding of how you can benefit from a variety of tax deductions available to hotel owners.  Can improvements actually pay for themselves through smart tax strategies like cost segregation and making energy efficient upgrades? Can you still take advantage of past renovations or somehow take a deduction for new equipment purchased or leased this year?  Looking at the big picture and working with the right professionals as you plan your renovations and upgrades can provide a big payoff in tax savings and boosting your cash flow this year and in years to come.

The hospitality industry has never been more competitive than it is today, as hotel owners face consumers’ increasingly high standards and reduced travel budgets, as well as increased operating and construction costs.  To survive in the industry today, it’s essential to understand the tax strategies that result in increased cash flow and can actually provide funding for renovations, improvements, and energy efficiency upgrades.  Understanding the tax opportunities that are currently available will allow you to develop a comprehensive plan for improvements that makes financial sense and allows you to maintain a property that offers everything today’s consumer demands.

Hotel owners face some unique challenges in maintaining a financially viable business.  There are building maintenance and renovation concerns, interior furnishings and often extensive exterior elements to oversee, as well as day to day operations, staffing and customer service.  Hotel owners looking at a “big picture” scenario of saving money through energy efficiency have to consider the cost of making the necessary improvements to the property. You might want to retrofit your existing hotel property with energy efficient lighting, HVAC or upgrades to the building envelope in order to save money on energy costs, but you’ve first got to come up with the funding for those improvements.   Do you provide the required capital or continue to face increased operating costs? 

The ROI on new, energy-efficient systems may take longer, but the equipment will perform more reliably while providing better working conditions and lowering energy costs along the way.   Most hotel owners will assume that funding for energy efficient upgrades has to come from dipping into their equity in the facility, or from an outside funding source such as a bank loan.  The good news is that hotel owners can take advantage of targeted tax and energy strategies that can significantly increase operating cash flow and generate a substantial ROI, as well as funding energy efficiency projects through a significantly lowered tax burden. 

A review of the real property assets may identify tangible personal property reducing the class lives to five, seven and 15 years for taxation purposes, which reduces current income tax obligations.  Personal property assets include a building’s non-structural elements, exterior land improvements and indirect construction costs.  Although the list is long, a few examples of items that can be reclassified include cabinetry, decorative millwork and lighting, some types of flooring and wall coverings, and specialty electrical and plumbing.  Hotels can typically benefit from this strategy because they contain large amounts of personal property in guest rooms, restaurants, and conference facilities. Exterior features such as paving, fencing, sidewalks and lighting are also eligible.  When these assets’ lives are shortened, depreciation expense is accelerated and tax payments are decreased, which frees up cash for other uses.

The ideal time to initiate this strategy  is during the planning phase of building a new property, remodeling or expanding an existing building.  At this time, project-related costs that qualify for a shorter depreciable life can be identified, segregated and reclassified as they are incurred, instead of waiting until the project is completed.  For capital construction projects and newly acquired buildings, an accurate assignment of costs will allow a taxpayer to "front load" cost recovery and cash flow, maximizing them in the immediate years following the construction or purchase.

However, the benefits of this strategy may be retroactive, including buildings that have been purchased, constructed, expanded or remodeled since 1987.  This allows taxpayers to bring forward previously unrecognized depreciation, which can significantly increase cash flow in the current year.

For those hotel owners who have leased or purchased equipment and put it into service in 2011, the §179 deduction and bonus depreciation will allow you to deduct the full purchase price (within specified dollar limits) of the equipment.

The Economic Stimulus Act of 2008 increased the §179 deduction limit to $500,000 and the total amount of equipment that can be purchased to $2 million from the previous amount of $200,000. A one-time Bonus Depreciation was also added, which now allows businesses to write off 100 percent of the purchase price of new equipment or other assets during the year they were purchased, as opposed to taking depreciation through annual deductions over time.

Most business equipment, software, office furniture and even some vehicles can qualify for the §179 deduction, including the following:

  • Equipment or machinery purchased for business use
  • Tangible personal property used in business
  • Business Vehicles with a gross vehicle weight in excess of 6,000 lbs
  • Computer Software
  • Office Furniture & Equipment
  • Property attached to your building that is not a structural component of the building (i.e.: a printing press, large manufacturing tools and equipment)
  • Partial Business Use (equipment that is purchased for business use and personal use – generally, your deduction will be based on the percentage of time you use the equipment for business purposes.)

Consider a scenario where you lease or finance some of the above equipment for your hotel property during 2011. Your business can deduct the full purchase price of that equipment in 2011, yet you’ve only made a few payments. Additionally, you have the benefit of putting the new equipment into use.

179D

Another potential tax benefit for hotel properties goes hand in hand with energy efficient building projects and improvements.  §179D of the Energy Policy Act of 2005 provides guidelines for tenants and building owners who may be eligible for tax deductions for implementing energy efficiency components in commercial buildings.  These deductions are applicable to buildings that were either built or retrofitted after December 31, 2005, and must be certified by a qualified third party.

§179D includes full and partial tax deductions for investments in energy efficient commercial buildings that are designed to increase the efficiency of energy-consuming functions.  The deduction available is up to $.60 per square foot for lighting, HVAC and building envelope, creating potential for $1.80 per square foot if all three components qualify.  Hotel owners can look at anything from energy efficient lighting and HVAC systems to air barrier systems, green roof or cool roof systems, insulation and sealant systems, insulated exterior cladding and deck coating, and window glazing or tinting to qualify for the §179D deduction.  Enlisting the aid of qualified professionals to coordinate your green/efficient building improvements can not only pinpoint the most effective improvements to make initially, but should result in a cohesive plan to ensure that you receive the maximum energy savings and tax benefit from your capital expenditure.  

Professional expertise is especially valuable when looking at HVAC system upgrades that will qualify for the §179D deduction.  The building that is to be improved with the new HVAC system must be modeled by a qualified individual using IRS prescribed software, and blueprints/plans and specifications for the new system also need to be provided.  In order for the HVAC system to qualify for the $.60 per square foot deduction, it must save at least 16 2/3% in energy costs over the minimum requirements established by ASHRAE 90.1-2001.  Based on the specific needs and characteristics of a hotel property, as well as the variety of HVAC and control systems available in the marketplace today, it makes sense to model any and all possible systems to find the most cost effective solution for the property.  Once the study has been completed, third party certification is required in order for the system to qualify.

With §179D deductions and future energy cost savings as incentives, making qualifying improvements to hotel facilities offers taxpayers powerful strategies to fund energy projects or increase cash flow.

In addition, the issuance of Revenue Procedure 2011-14 will allow some taxpayers to claim the §179D deduction all the way back to January 1, 2006 without filing one single amended income tax return. This means that a taxpayer could potentially claim deductions from 2006-2010 (or 2011) all on one return and significantly reduce their tax burden, if not eliminate it altogether.

The opportunities for tax savings and enhanced planning are available with the right knowledge and planning.  Putting these effective tax and energy strategies to work for you makes smart business sense and can make the difference in today’s hospitality marketplace.

For more information please contact crginfo@capitalreviewgroup.com directly at 602.741.7776

CAPITAL REVIEW GROUP does not advise on any personal income tax requirements or issues. Use of any information from this document or web site referred to is for general information only and does not represent personal tax advice either express or implied. You are encouraged to seek professional tax advice for personal income tax questions and assistance.

Marky Moore, Founder of Capital Review Group in Phoenix is a Certified Sustainable Building Advisor and an Accredited Professional for the U.S. Green Building Council's Leadership in Energy and Environmental Design (LEED AP) and has a thorough understanding of green building practices and principles, as well as the LEED rating system. 

She works with engineers and architects on one hand, and CPAs and tax advisors on the other, to achieve the maximum Federal Tax deductions for a building's energy efficiency and depreciation. She started CRG in 2004 to provide critical tax and specialty services to professional advisors, clients and institutional partners. The company offers services in several major areas:, the 2005 Energy Policy Act/Section 179D, business tax credits and specialty construction/engineering consulting, and Cost Segregation. Ms. Moore is a featured speaker in the industry and has authored articles for major industry publications.


Contact:

Marky Moore
Capital Review Group
602.741.7776
crginfo@capitalreviewgroup.com


 
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