Owning a car dealership can present a golden opportunity to reduce your tax liabilities. One such opportunity is cost segregation, allowing dealerships to speed up depreciation deductions, which can lead to significant tax savings early on. In this article, we’ll break down cost segregation, explain how it works, and show why it’s crucial for improving your cash flow and overall financial bottom line.
What Is Cost Segregation?
Cost segregation is a tax strategy involving an engineering-based analysis that identifies, segregates, and reclassifies various property components that can be written off faster than others instead of spreading out the depreciation over 39 years. Cost segregation allows you to classify certain portions of the property, such as parking lots, showrooms, service centers, and offices, into shorter depreciable periods, such as 5, 7, or 15 years. This means larger deductions early on, which can reduce your taxable income and free up cash for other investments.
How Does Cost Segregation Work?
A cost segregation study is typically conducted by cost segregation specialists, engineers, construction professionals, and/or tax experts who specialize in this field and follow IRS guidelines. The studies typically are completed in several steps:
- Initial Property Assessment
- Property Inspection
- Obtain and Review Necessary Project Information and Documentation
- Perform Detailed Engineering/Estimating Take-offs
- Provide a Comprehensive Report
What Is Bonus Depreciation?
Bonus depreciation is a tax incentive created by Congress that allows businesses to immediately deduct a significant portion of eligible assets purchased, constructed, and/or renovated rather than writing them off over the asset’s “useful life.”. The rules and limitations have evolved over the years, and in 2017, the law changed again, which allowed for a 100% deduction for qualified assets through the end of 2022. As part of the change in law, bonus depreciation is scheduled to be phased down to zero in 20% increments from 2023 through the end of 2026. Starting in 2027, bonus depreciation will be suspended again unless Congress acts.
Examples of Assets That Qualify for Bonus Depreciation
- Furniture and fixtures
- Service equipment
- Land Improvements
- Interior improvements
- Specialized HVAC, Plumbing, and Electrical systems
What Is Section 179 Deduction?
This deduction is another key tax incentive allowing dealerships to deduct the full cost of new and used qualifying equipment, software, and other assets in the year they were purchased rather than depreciating them over their “useful life.” In 2024, the maximum deduction is $1.12 million, with phase-out limits of $2.8 million.
Impact of Interest Limits on Bonus Depreciation
Bonus depreciation and business interest deductions are interrelated and can impact how dealerships optimize their tax strategy. Even with interest expenses, a dealership can still benefit from bonus depreciation, but they need to ensure their total interest expense stays below certain thresholds to maximize deductions. Regularly reviewing your interest expenses and adjusted taxable income is a smart tax planning strategy.
Case Study Examples
- A dealership recently constructed a property for $12 million. By identifying $3.5 million of assets to shorter depreciable tax lives, the dealership realized over $2.3 million in first-year depreciation deductions (with the help of bonus depreciation) and over $680,000 in tax savings during the first year, boosting their cash flow and profitability.
- A dealership never performed a cost segregation study on a property they purchased for $15 million back in 2021. By performing a look-back study on the property, the dealership was able to reclaim the missed deductions from prior tax years. By identifying over $4.4 million of misclassified assets and the recovery of the understated depreciation deductions from prior and current tax year(s), the dealership realized over $4.4 million of depreciation deductions (with the help of bonus depreciation) and over $1.2 million in tax savings in 2024, thereby increasing their financial bottom-line.
- A dealership recently remodeled its facility for $5 million. By identifying $3.6 million of assets to shorter depreciable tax lives, the dealership realized over $2.2 million in first-year depreciation deductions (with the help of bonus depreciation) and over $650,000 in tax savings during the first year. An additional benefit of the remodel was the portion of assets that were demolished to make way for the remodeling of the building. The dealership was able to write off completely the remaining basis of those demolished assets in the year they retired. The financial benefits to the dealership were beneficial in helping to increase their cash flow and profitability.
Additional Financial Benefits
- Electric Vehicle (EV) Charging Stations: Tax credits are available for installing EV chargers, potentially providing a credit of up to 30%, based on certain requirements and capped at $1000,000 per station.
- Solar Panel Systems: Similar to EV chargers, solar panel systems can qualify for tax credits up to 50%, based on certain requirements.
- Both the EV chargers and solar panel systems are also eligible for bonus depreciation on top of the tax credits at reduced rates.
If you’re a dealership, it’s worth exploring whether cost segregation is right for you and your property.
Contact Us
For more information on this topic, please contact a member of Withum’s Dealership Services Team.
