A Matter Of Savings Accelerating Medical Office Building Depreciation Can Bring Benefits

In 1993, the federal government increased the depreciation period for commercial real estate from 31.5 years to 39 years. This created a disincentive for medical practices to acquire their own medical office buildings.
With banks reluctant to finance such acquisitions beyond 15 or 20 years, this created a cash-flow deficit for medical practices because only half of the principal payments on debt were recoverable through depreciation deductions. This also necessitated debt refinancing at unattractive interest rates, thus increasing the cash flow drain.

A cost-segregation study can enable you to significantly shorten the overall depreciation period of medical office space. This in turn accelerates expense deductions, which decreases taxable income and frees up cash for other uses. A typical cost-segregation study can reduce the recovery period of 30-40{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} of the total project costs to less than half of what conventional depreciation methods allow.

How It’s Done

Cost segregation studies are performed by certain CPA firms and other organizations that are specially trained in income tax law, property tax law, and architectural and engineering science, and who have a comprehensive database of court cases and applicable IRS rulings specifically related to the issues add-ressed in a cost-segregation study.

By physical inspection and analysis of architectural drawings, contractor estimates, pay requests, change orders, invoices, and engineering notes, the cost-segregation firm is able to reclassify certain costs — normally considered to be 39-year recovery property — to five-, seven-, 10-, or 15-year recovery. This is documented in a formal report which should be retained for tax purposes.

The following actual case illustrates the savings from a cost-segregation study. Northeast Medical Associates, LLP constructed a 5,000-square-foot medical office building at a total cost of $672,000. The cost-segregation study resulted in reclassifying $251,000 of costs from 39-year recovery property to five-, seven-, and 15-year property.

The impact of this was to increase the depreciation deductions in the first six years of the building by $168,000. This increase saved the medical practice over $60,000 in income taxes in the first six years. The present value of the tax savings was approximately $35,000. The cost of this particular study was $4,500, which was fully deductible. Generally, the present value of cash savings ranges from seven to 10 times the cost of the study.

The savings can be even higher as a result of the Job Creation and Worker Assistance Act of 2002, which allows a depreciation bonus of 30{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} for qualified property acquired after Sept. 10, 2001.

If your medical practice has already constructed a facility and filed income tax returns using the conventional 39-year recovery period, you may be able to file for an accounting change and file amended returns, if applicable.

Real Benefits

The turnaround time of a cost-segregation study is generally two to three weeks from the date the consulting firm receives all the required drawings and other supporting documentation.

The cash savings from a cost-segregation study are too significant to ignore. The savings can be compounded by applying the cash to the mortgage loan principal, thus reducing the total interest costs over the life of the loan.

James B. Calnan, CPA, is partner-in-charge of the Health Care Services Division of Meyers Brothers, P.C. in Longmeadow; (413) 567-6101.