Cost segregation can create a much larger depreciation deduction for owners of commercial buildings and currently applies to both hemp and THC cannabis, although 280E does make it so that the building used for THC plant touching activities must be owned separately and rented to the marijuana business while the rental gets the accelerated depreciation benefit.
Depreciation is an annual allowance for wear and tear, deterioration, or obsolescence of a property. Most business owners will have their CPA calculate depreciation as there can be multiple methods to choose from. The recent Tax Cuts And Jobs Act even doubled the amount of accelerated depreciation allowed. A very important piece in a depreciation calculation is the cost of the building itself.
Most owners will know the purchase or renovation cost and their accountant will break that down further by separating out the land cost. But most owners or accountants do not know the individual costs of the semi-permanent fixtures inside the building like floors, walls, ceilings, wiring, fire suppression, or landscaping, so those items cannot easily be separated from the depreciation of the building itself. Hence, the term cost segregation is used for the process to determine these costs as separate from the whole building.
Once the cost of those items is established an accountant can then depreciate them separately over five, seven, or 15 years and doing so creates a much more significant upfront tax break by taking the back end of 27.5- or 39-year depreciation and front-loading it. The savings can then be used by the owner to reduce debt and/or pay for expansion, or for hemp and cannabis companies to cover the additional costs associated with modifications needed to stay compliant as new regulatory requirements for hemp (and ultimately for cannabis) are released. The goal of cost segregation is to compound on the future depreciation that they receive upfront.
There are 4 different IRS-approved methods to complete a cost segregation study. Some involve estimations while others involve more precise data. An engineering firm that specializes in such work can provide specific documentation in a format that creates more tax savings than an estimate otherwise would, so most CPAs or accountants do not provide this service themselves. Cost segregation can be facilitated immediately after purchasing, building or renovating a property, or it can be completed up to 20 years after the property acquisition. Service providers should be experienced professionals with a significant track record that back up their work with audit protection guarantees. Almost any commercial property acquired (for $750,000+) or renovated (for $250,000+) can be effectively considered for cost segregation to accelerate depreciation deductions.
Building owners who engage a cost segregation study should be prepared to own the building for at least three years because selling a property where accelerated depreciation deductions have been taken can result in recapture, meaning giving back some of the tax savings that was front-loaded to the owner. There are ways to reduce the impact of recapture, one being especially useful if they buyer of the building plans to fully renovate after the purchase. An experienced CPA can offer additional guidance in this area.
Ownership of commercial property, or most real property for that matter, comes with additional costs, including specific property taxes. The most common is real property tax, but in some jurisdictions there can be a different type -- business personal property tax. That is the exact definition of the separate items listed in the cost segregation study. Some of these jurisdictions may charge a different (and lower) tax rate, while others charge the same rate but don't index the cost of business personal property for inflation. If you provide a list of business personal property assets to your taxing authority, they may be able to only assess the inflation adjustment every two years on the value of the real property (less the business personal property items). This can be an added benefit to a cost segregation study and should be considered wherever relevant.
Another way to reduce property tax is to protest the valuation that is provided every two years. Most people who do this rely on comps (comparable properties nearby) but many do not know there are four other means to assess value, each of which can be instrumental in making the case to reduce the otherwise inflated value and resulting property tax. These methods include cost, market, and income approaches to value as well as potential uniformity issues. Quite often, the initial protest gets declined and appeals need to be made to different layers of management before the process can be argued in court for a judge to decide. While that may sound arduous, the process is much simpler when you hire a specialist to do the work and split the savings instead of paying an upfront fee regardless of result obtained. In these cases, it costs you nothing if the appeals are unsuccessful.
Regardless of which tool or combination of tools helps you uncover hidden money, I hope this series of articles has given additional thought to where you can squeeze more profit from your business and how you can use that, along with other strategic choices to best prepare your hemp or cannabis business for the significant impact upcoming regulatory changes will have on us all.
In the end, more oversight will benefit consumers, but the rewards are likely to go to those who choose to get ahead of the curve and not have to reduce operations because they weren't ready to meet the regulations head-on once they are implemented.
Sean Covi, CFP, works with businesses and their tax planners to help them implement underutilized expense controls that reduce tax and operational costs with an emphasis on improving profit and financial performance. The strategies he brings are often overlooked by CPAs because they are not directly accounting-related, they may not know which programs are allowed within the parameters of code section 280E, or in the case of hemp, they are no longer bound by CSA schedule I or 280E, so many business owners don't even know such tools exist to save them money. Call Sean at (303) 931-3697 or send him an email.