Is Cost Segregation Beneficial for Restaurant Owners?

[Julio Gonzalez]

Restaurants may not be the first thing that comes to mind when we talk about cost segregation, but their unique business model makes them fitting candidates for this strategy. Along with their physical infrastructure, restaurants are rich in potential assets that could unlock significant tax savings for restaurant owners.

How can cost segregation benefit restaurant owners?

The goal of cost segregation is to identify and reclassify personal property assets to shorten depreciation times and increase your immediate tax deductions.

Restaurants are uniquely positioned to leverage this strategy, as they are laden with assets that could be reclassified from long-lived property (depreciated over 39 years) to short-lived property (depreciated over five, 7, or 15 years).

Some of the many assets that may qualify for reclassification include:

• Specific components of the HVAC system serving your kitchen and dining areas
• Commercial kitchen equipment, such as ovens, refrigerators and fryers
• Specialized lighting fixtures

The full scope of potential savings can be explored through a cost segregation study.

By accelerating depreciation deductions early on in restaurant ownership, you can reap significant tax savings and improve your cash flow as a result.

When should you consider cost segregation?

Cost segregation can be performed at any stage of ownership:

• At launch. For new construction or renovations, cost segregation provides immediate benefits and enhanced cash flow at the onset.
• During expansions or leasehold improvements. Adding new assets, such as specialized kitchen equipment or light fixtures, can often be classified under short-lived categories. Identifying and reallocating these assets results in tax savings that can offset some of your expansion or improvement costs.
• Established, older restaurants. Yes, even older restaurants can benefit from cost segregation. If you have been depreciating for several years, a “look-back” cost segregation study may be an option and will allow you to claim depreciation you could have leveraged in the past.

Of course, the benefits of cost segregation go beyond just the immediate tax savings. Over the long-term, this is a tax strategy that can amplify profitability and provide the financial flexibility you need to stay ahead in this competitive industry.

What are your thoughts on cost segregation for restaurants?

[Sean Graham]

Quote from @Stephen Nelson:

I defer to Julio on the technical details of the cost segregation. (Full disclosure here: We've had many clients work with his team over the years.)

But if I could go off a slight tangent? I'd say that one really useful and underappreciated tactic here is for the small business owner (so could be a restaurant owner but could be any other small business too) to buy a building, rent that building to the business she or he owns, do a cost segregation study to front load all the depreciation into the early years, and then make a Reg 1.469-4(c) grouping election. 

In general, you can't group rental activities with non-rental activities. But some exceptions exist including one for when a self-rental occurs. The rule from 1.469-4(d)(1)(C) says this:

(C) Each owner of the trade or business activity has the same proportionate ownership interest in the rental activity, in which case the portion of the rental activity that involves the rental of items of property for use in the trade or business activity may be grouped with the trade or business activity.

This is probably obvious but with this tactic, you don't worry about Section 469's per se classification of real estate as passive because you've rolled up the real estate activity into the other non-real-estate-rental business. Furthermore, because the business owner surely materially participates in her or his business, you automatically have material participation in most cases.

The one trick there though: You need to group when you buy the building.

Very good info!