As collision repair businesses look for ways to protect profitability in a challenging market, one often-overlooked opportunity may be hiding in their real estate. A cost segregation study can help shop owners accelerate depreciation, reduce taxable income and improve cash flow.

Most commercial buildings are depreciated over 39 years. But a cost segregation study breaks down the building into individual components and identifies assets that qualify for shorter depreciation schedules, which are typically five, seven, or 15 years. Items such as flooring, specialty lighting, signage, electrical infrastructure, site improvements, and other shop-related assets may qualify for accelerated depreciation.

When I built my second shop in 2002, a cost segregation study allowed me to accelerate approximately $900,000 in depreciation from a project that cost about $4 million. Because of that, I was able to take larger tax deductions earlier in the life of the building, which gave me immediate cash flow benefits.

And this strategy can also benefit a variety of income-producing properties, including rental real estate and other commercial buildings. For additional background for this column, I reached out to Eric Hencken, who used to be my GEICO appraiser when I owned Wagon Work Collision. He’s the co-founder and managing director of Porto Leone Consulting, and cost segregation services are one of his firm's specialties. 

Collision repair facilities are often strong candidates, Eric said, because they contain many specialized components beyond the building shell itself. Qualifying assets can include specialty lighting, removable partitions, electrical systems feeding shop equipment, air lines, specialty exhaust systems, garage door openers and other operational infrastructure. Site improvements such as paving, sidewalks, curbing, fencing, and parking lot lighting may also qualify for shorter depreciation schedules.

What a Study Includes

A cost segregation study typically involves reviewing construction or purchase records, examining building plans, conducting a site visit, and documenting qualifying assets. Using video conferencing technology, Eric said, many studies can now be completed through a virtual walkthrough. The final report allocates assets into appropriate depreciation categories and is designed to comply with IRS audit guidelines.

Eric also recently completed a study on a collision repair facility purchased for $2 million. After removing $400,000 attributed to non-depreciable land, the remaining $1.6 million basis was analyzed. The study moved 22% of the property into five-year assets and another 8% into 15-year assets, reclassifying approximately $475,000 into shorter depreciation schedules. At a 35% tax rate, the estimated tax benefit was roughly $165,000.

There are, however, important considerations. Eric stressed that property owners should work closely with their CPA or tax advisor before moving forward. While accelerated depreciation can provide significant near-term tax savings, owners should understand the depreciation recapture rules that may apply when a property is sold. Although his firm's staff are cost segregation experts, they work with the shop's accountant or tax advisor to plan for the shop's individual circumstances.

The timing of a study also matters. Ideally, a cost segregation study is completed when a building is first placed into service. However, Eric noted that many owners who purchased or built facilities several years ago may still qualify. Through IRS Form 3115, taxpayers can often catch up on missed depreciation benefits from prior years.

Another common misconception involves land. Land itself is not depreciable and must be separated from the building's basis before a cost segregation analysis can be performed. Land improvements, however, such as paving and fencing, may still qualify for accelerated depreciation.

For me, the larger issue is awareness. Many shop owners simply do not know the strategy exists, and many accountants focus primarily on tax preparation rather than proactive tax planning.

As shops continue looking for ways to strengthen cash flow, cost segregation may be one of the most valuable financial tools you are not currently using. For owners who have built, purchased or expanded a facility, it may be worth asking a simple question: Are there tax savings hiding inside your building?