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Bruce Bryen is a certified public accountant with over 45 years of experience and is a part of Baratz & Associates CPAs. He specializes in deferred compensation, such as retirement planning design; income and estate tax planning; determination of the proper organizational business structure; asset protection and structuring loan packages for presentation to financial institutions. He is experienced in providing litigation support services to dentists with Valuation and Expert Witness testimony in matrimonial and partnership dispute cases. He is also a financial writer for several dental journals. You may contact him at 609-502-0691 or at Bryenb@baratzcpa.com.
There are few financial advisors (and even fewer dentists) who have ever heard of cost segregation depreciation. Dentists are constantly requesting tax advice from their CPAs as well as their financial advisors and consultants. Since they are high-income earners, they want the best people advising them about tax write-offs and how fast they can get them. Most know the guidelines for section 179 depreciation, which involves a quick write-off for depreciation for equipment and other non-real property related assets. When the question is posed about cost segregation depreciation, they are at a loss to comprehend that something like this exists.
Here is a quick tutorial as to the type of asset it involves and the effect of it on that asset. What it means in terms of money today for the dentist and how it evolves is another dramatic point of interest to the dentist. The basic concept of cost segregation depreciation is that it is a quick write-off for real estate-related assets.
Here is an example of cost segregation depreciation and why it is important to the dentist. Suppose a dentist acquires a dental practice, as well as the real estate where the dental practice is housed. There is typically negotiating that takes place regarding the dental practice sales price and the allocation of its assets. In many circumstances, the dentist has the opportunity to buy the real estate as well. A financial and tax advisor may suggest holding off on the real estate because of the tax effect of that real estate. When real estate is acquired, in most instances, there is not much of a tax effect from it as a positive write-off against taxable income from the dental practice. Commercial real estate has an IRS guideline life of 39 years for depreciation purposes with no allocation for the land. As an example, if the real estate housing the dental practice sold for $500,000 and the land had a value of $110,000, the depreciable improvements would be allocated an amount of $390,000. There would be no tax write-off for the land and the improvements would generate a tax write-off of $10,000 a year for 39 years, or the $390,000 total. The $10,000 per year in write-offs would generate $5,000 per year in tax savings, assuming a 50% tax bracket for the dentist.
By engaging an engineering study that would allocate the specific items that composed the real estate structure such as specialty lighting, plumbing, partitioning, etc., there may be items that are special enough that they would have their own guideline lives. As an example, special lighting that may have a cost of $100,000 may have a guideline life of only seven years. If the engineer’s report can segregate that item and there is proof of its special circumstances, the $100,000 would be depreciated over seven years at the rate of $14,286 per year. If special plumbing also existed with a life of 10 years and cost of $75,000, that would generate a depreciation tax write-off of $7,500 per annum. So, in comparison to the 39 years of depreciation on the $390,000, equaling $10,000 per annum, we would have $14,286 of depreciation for special lighting that we can prove would last seven years and the $7,500 per year depreciation on the plumbing that would last 10 years for a total of $21,786, plus 39 years of depreciation on the balance of the $215,000 ($390,000 minus $100,000 for lighting and $75,000 for plumbing). That would depreciate over 39 years, or $5,513 per year. Our first year depreciation would be $14,286, plus $7,500, plus $5,513 or a total of $27,299 compared to $10,000. Instead of saving 50% of $10,000 in taxes, or $5,000, the dentist would save 50% of $27,299, or $13,650. That’s a difference in tax savings of $13,650 minus $5,000, or $8,650. That’s in today’s money and can be used for anything at all, such as a payment to assist in funding a retirement plan.
The interpolation of a higher priced property can be determined easily enough to determine the actual amount involved with a specific transaction.
Remember that depreciation on any asset amount is the same. The question is how fast that depreciation is taken and how much money is in hand today. Advisors should be discussing present value calculations to let the dentist know how much a dollar is worth today compared to getting that dollar over 39 years. This gives the actual real time effect to the dentist.