News for the Hospitality Executive
The Value of Cost Segregation for Hotels & Motels
By Israel Segal, September 2008
Hotels and motels can significantly reduce their taxes through a process
called cost segregation. In fact, cost segregation has become one of the
most vital aspects of hotel/motel financing with tax consequences that
can significantly add to a facility’s bottom line.
According to federal tax laws, cost segregation consists of identifying personal property assets that are grouped with real property assets, then separating personal assets for tax reporting purposes. In order to do this, one must hire an experienced engineer who should have a well-rounded understanding of construction finance, to produce a cost segregation analysis that identifies and classifies personal property assets so that depreciation time is dramatically truncated thus reducing one’s tax obligations.
What is personal property? It consists of a building’s non-structural elements, exterior land improvements, and indirect construction costs.
The engineer that one retains will examine all blueprints as well as architectural drawings, electrical plans, and isolate structural and mechanical components from those that are considered personal property. The cost segregation report will also identify architectural and engineering fees that can be segregated.
The report will identify “soft costs,” such as architectural and engineering fees, that are components of the building. In addition a well documented and thorough cost segregation analysis will do the following:
The larger tax deductions will result in increased cash ?ow and a lower cost of capital, especially during the ?rst few years following an expansion project, renovation, or purchase. A cost segregation study can significantly help identify opportunities for such periods of accelerated depreciation.
In order for hotels and motels to take full advantage of cost segregation opportunities, buildings must have been purchased, constructed, renovated, or expanded after 1987. While cost segregation is cost effective for such new buildings, a well done study can uncover tax deductions for buildings that pre date 1987. In addition, buildings that are best suited for cost segregation should have a cost basis that is greater than $500,000.
In addition to providing tax relief, cost segregation can benefit the owners and operators of hotels and motels in the following ways:
An example of Cost Segregation: Suppose an individual purchases a hotel/motel for $10,000,000 while the land is owned by another entity. If the purchaser does not use cost segregation, then straight-line depreciation over 39 years must be used.
If, however, an engineer is retained and produces a report that shows that of the total purchase price, $9,000,000 should be for the building and $800,000 for a parking lot, and $50,000 for landscaping and shrubbery, the hotel owner could save more than $100,000 assuming a tax rate of 35% and 5% discount rate.
There is an another example of the tax savings that can result from cost segregation. Suppose a cost segregation analysis shows that a buildings siding had an initial value of $200,000. Five years later, it has a value of $150,000 and must be replaced. The hotel/motel owner could deduct $150,000 as a loss. Without a cost segregation study, the owner would be not able to take the deduction because the siding’s tax basis and the cost basis of the building would not have been itemized as separate entities.
Altogether, a cost segregation study is an essential fiduciary component when one does any of the following:
|Also See:||Depreciating Assets: What Hotel Owners Should Be Considering / Kevin F. Reilly / July 2004|
|Winds Blow in Washington DC; Tax Code Changes Affecting The Lodging Industry / May 2006|