Post pandemic changes continue to take root in the commercial real estate space and especially with restaurants. It was inevitable that given the scare the American people were put through with the Covid hysteria that we’d see an increase in drive-thrus and pick up windows. Pick up windows have long been a thing in beach towns and resorts but they are now making their way to every day suburban America.
Smashburger is testing out virtual lanes whereby they create some space in their stores to cut out a pick up window. Customers place their orders on their app and pay for it electronically. They then just walk up and pick up their order. Panera does a lot of this as do other restaurants, but you have to go into their stores to get the food. That’s fine now, but for those looking to shave 30 seconds off their lives, they may like the pick up windows. This allows Smashburger to provide some additional convenience for customers without needing the real estate to double or triple their drive-thrus which of course also costs a significant amount of money.
Cost segregation works pretty much on all commercial buildings. If the building cost is north of $175,000 or so, there are tax savings being left on the table if the owner does not segregate the building in to 5, 7, 15, and 39 year class lives which is what happens when you do an engineering-based cost segregation study.
What might one see for results in such a study for a Panera Bread commercial building? Well, the owner might save about $100,000 on his/her income taxes by doing a study. The cost of the study would be a small fraction of the overall savings.
Let’s say in this scenario we have the following:
Building Cost: $1,500,000
Increased Accumulated Depreciation: $310,000
Estimated Tax Savings @32% Federal Rate: $99,200
The building owner doesn’t have to write a check to the IRS for that $99,200. The money stays in his/her bank account and they can do with it as they see fit….remodel bathrooms, buy a new building, buy a new car, pay off debt, increase wages for employees, buy a short term rental, take some vacations….they money is there’s and remains with them. I don’t care how much money people have…they could have millions, but there hasn’t been a single person yet that I’ve come across who says they aren’t interested in keeping an extra $100,000. And it doesn’t have to be $100,000….we run scenarios for all kinds of property…let’s say you own a building that is only $300,000 but by doing an engineering-based cost segregation study, you might be able to save $15,000-$20,000 on your taxes. That’s real money and people would rather keep that money in their bank accounts rather than the IRS’s.
Note, the numbers above are estimated tax savings. Each study is different and we wouldn’t know the final results until the actual study is completed. A building owner’s tax situation and tax rate might be different. If they were in the 37% tax bracket their tax savings would be quite a bit higher. If they are in a lower bracket then the savings would be lower. As always, I can’t give tax advice. When considering cost segregation, get an estimate and then discuss it with your own tax professional to see if you can benefit from doing a study.
Does cost segregation work for restaurant buildings? It absolutely does! The U.S. is filled with buildings like the one above for TGI Fridays. I’m just using this as an example.
Restaurant buildings typically are owned by someone else and not the restaurant owner. If they are owned by the restaurant owner, then that owner might consider grouping his/her real estate entity with the restaurant operating entity to take advantage of the tax savings with cost segregation. To make the designation to “group” those entities, it must be done in the first year you file taxes for the building. Here’s a helpful article about grouping for business owners.
Most restaurants have nicely finished interiors as well as lots of parking. Both are key to taking advantage of the tax savings available through cost segregation. A lot of the internal finishing is going to be reclassified as 5 year class life property. The parking lot, landscaping and overall site improvements will be classified as 15 year class life property. For buildings purchased between September 28, 2017 up until December 31, 2022, the owners can take 100% bonus depeciation on all property with a class life less than 20 years. So obviously all that 5 and 15 year property can be 100% bonus.
What do the numbers look like? Let’s run the following scenario. Let’s say the restaurant was purchased in July 2022 for $1,850,000. The land might be valued at $400,000. So the amount of building basis to be studied is $1,450,000. Of the $1.45MM property, it may be reclassified as follows: (note…these are just estimates based upon experience…each building may have a higher or lower % of the various class lives):
5 year property: 18% / 261,000
15 year property: 8% / 116,000
Total Accumulated Depreciation Expense: 377,000
Tax Savings at 32% Federal Tax Rate: $120,640
Cost: $5,500 – $6,500
Net Cost After Tax: $4,080 (if study is $6k)
ROI: 30:1 —> that’s 3,000% return by the way
BTW, if the owner continues to take just straight line depreciation 1/39th each year, that equates to about 2.5% of the building basis or approximately $36,250 each year. It would take more than 10 years for this owner to get the depreciation on this building that he/she could take with just one year doing cost segregation.
It’s nearly 90% of the owners I speak with have no idea of the tax savings available to them. Their commercial brokers are bringing it up. Their CPAs aren’t bringing it up. So I’m trying to get the word out to help these business / building owners maximize their buildings, reduce their tax burden and drive greater cashflow. It’s not a bad gig.
This does not constitute tax advice. I’m just showing what we might be able to do for this type of building. I recommend that you discuss cost segregation and your particular tax situation with your CPA or tax professional.
